Give It To Me Straight: How, When, and Why Managers Disclose Inside Information

About Seasoned Equity Offerings

by

John R. Busenbark

A Dissertation Presented in Partial Fulfillment

of the Requirements for the Degree

Doctor of Philosophy

Approved February 2017 by the

Graduate Supervisory Committee:

S. Trevis Certo, Chair

Albert Cannella

Matthew Semadeni

ARIZONA STATE UNIVERSITY

May 2017

i

ABSTRACT

Managers‘ control over the timing and content of information disclosure

represents a significant strategic tool which they can use at their discretion. However,

extant theoretical perspectives offer incongruent arguments and incompatible predictions

about when and why managers would release inside information about their firms. More

specifically, agency theory and theories within competitive dynamics provide competing

hypotheses about when and why managers would disclose inside information about their

firms. In this study, I highlight how voluntary disclosure theory may help to coalesce

these two theoretical perspectives. Voluntary disclosure theory predicts that managers

will release inside information when managers perceive that the benefits outweigh the

costs of doing so. Accordingly, I posit that competitive dynamics introduce the costs

associated with disclosing information (i.e., proprietary costs) and that agency theory

highlights the benefits associated with disclosing information. Examining the context of

seasoned equity offerings (SEOs), I identify three ways managers can use information in

SEO prospectuses. I hypothesize that competitive intensity increases proprietary costs

that will reduce disclosure of inside information but will increase discussing the

organization positively. I then hypothesize that capital market participants (e.g., security

analysts and investors) may prefer managers to provide more, clearer, and positive

information about the SEO and their firms. I find support for many of my hypotheses.

ii

TABLE OF CONTENTS

Page

LIST OF TABLES ......................................................................................................... iv

LIST OF FIGURES ........................................................................................................ v

CHAPTER

1 INTRODUCTION ....................................................................................................... 1

2 LITERATURE REVIEW AND THEORETICAL DEVELOPMENT......................... 8

Information Asymmetry, Agency Concerns, and Controversial Activities .............. 8

Seasoned Equity Offerings as Controversial Activities ........................................... 11

Proprietary Information as a Strategic Mechanism ................................................. 17

3 THEORY AND TESTABLE HYPOTHESES ........................................................... 29

Proprietary Costs and Competitive Dynamics—Antecedents ................................. 29

Security Analyst Reactions—Consequences ........................................................... 41

4 METHODOLOGY AND EMPIRICAL ESTIMATION ............................................ 54

Sample...................................................................................................................... 54

Testing the Antecedents of the Uses of Information .............................................. 56

Testing the Consequences of the Uses of Information ............................................ 62

5 RESULTS ................................................................................................................... 70

6 DISCUSSION ............................................................................................................. 74

Limitations ............................................................................................................... 79

Future Directions ..................................................................................................... 82

Conclusion ............................................................................................................... 87

REFERENCES .............................................................................................................. 89

iii

APPENDIX

A FIGURE AND TABLES FOR THIS STUDY .................................................. 110

iv

LIST OF TABLES

Table Page

1. Descriptive Statistics ............................................................................................... 112

2. Testing the Antecedents of the Uses of Information .............................................. 113

3. Testing the Consequences of the Uses of Information ............................................ 114

4. Industries Removed from the Sample ..................................................................... 115

v

LIST OF FIGURES

Figure Page

1. Overview of the Model ........................................................................................... 111

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CHAPTER 1

INTRODUCTION

Introduction

Information about an organization is important for investors and managers alike.

Agency theory suggests that information asymmetries between managers and investors

create the potential for managers to act opportunistically at the expense of investors

(Eisenhardt, 1989; Fama, 1980; Jensen & Meckling, 1976). Because of this paradigm, a

robust corporate governance literature outlines the mechanisms capital market

participants can use to reduce information asymmetry (e.g., Bebchuk & Weisbach, 2009;

Daily, Dalton, & Cannella, 2003a; Finkelstein, Hambrick, & Cannella, 2009). As

information asymmetry increases, capital market responses to strategic activities should

reflect the perceived value of the activity and also a discount for agency-related concerns

(Corwin, 2003).

Given this conceptualization of information asymmetry and market reactions,

research documents how managers can use information announcements to their firms‘

advantage (e.g., Graffin, Haleblian, & Kiley, 2016; Healy & Palepu, 2001; Libby & Tan,

1999). Since managers have more information about the operations of the firm than

capital market participants do, they can control the timing and content of information

releases in order to help improve capital market reactions to strategic announcements

(Fiss & Zajac, 2006; Graffin, Carpenter, & Boivie, 2011; Washburn & Bromiley, 2013).

Some scholars suggest that managers can release more information about a strategic

event itself to improve capital market reactions to the event (e.g., Fiss & Zajac, 2006;

Washburn & Bromiley, 2013). Other scholars have posited that managers can provide

2

more information about other elements of the organization to distract from the event itself

and improve capital market reactions (e.g., Graffin et al., 2016; Graffin et al., 2011).

Regardless of exactly how managers use their inside information, these tactics tend to

involve releasing more information about the firm and thus lowering the veil of

information asymmetry.

Lowering the veil of information asymmetry, however, often represents an

unrealistic solution that potentially undermines the firm‘s ongoing performance. One

major reason for this involves the potential proprietary costs associated with disclosing

information (Healy & Palepu, 2001; Lang & Sul, 2014; Verrecchia, 1990b). Proprietary

costs refer to the decrease in future firm performance associated with the advantages

competitors gain from receiving more information about the firm (Verrecchia, 1990b,

1990a). When managers employ tactics aimed at using their inside information to

improve capital market reactions, competitors can use it against the announcing firm.

This presents quite a paradox for managers. On one hand, managers face a high incentive

to provide more information about their firm in order to improve capital market reactions

associated with potentially controversial activities. On the other hand, managers are often

wary of disclosing their proprietary information because it may actually hamper firm

performance when competitors use this information for their own benefit.

This paradox pits the predictions of agency theory against those of theories within

competitive dynamics. Agency theory suggests that managers benefit from disclosing

more information about their firms to outsiders because of the benefits of reducing

information asymmetry (Bebchuk & Weisbach, 2009; Dhaliwal et al., 2011; Eisenhardt,

1989). Theories within competitive dynamics, however, suggest that managers may either

3

(a) not want to disclose inside information because of proprietary costs (Chen & Miller,

2015) or (b) want to disclose information only to shape competitors‘ perceptions and

reactions (Gao, Yu, & Cannella, 2016).

In this study, I examine this theoretical tension through the lens of voluntary

disclosure theory. Voluntary disclosure theory predicts that managers will release

information when they perceive the benefits of doing so outweigh the costs (Guidry &

Patten, 2012; Lewis, Walls, & Dowell, 2013). I conceptualize the costs of releasing inside

information as those corresponding with the proprietary costs of competitors potentially

using inside information against the firm. These costs may arise from performance

declines associated with competitors using information at the expense of the disclosing

firm. They may also arise from investors concerns‘ over competitors using information in

this way. I conceptualize the benefits of releasing information as those corresponding

with better stock market reactions from investors receiving more material information on

which they can value the firm.

I examine these costs and benefits in the context of seasoned equity offerings

(SEOs). SEOs represent often necessary, but frequently controversial, activities in which

managers engage (Henry & Koski, 2010). SEOs are necessary because managers often

use them to raise capital when needed to fund future activities, but are controversial

because outsiders can associate them with managers taking advantage of overvaluation

(Brisker, Colak, & Peterson, 2014; Henry & Koski, 2010). By SEOs, I am referring to a

dilutive activity wherein a firm issues more equity in exchange for capital (e.g., Autore,

Bray, & Peterson, 2009; Kalay & Shimrat, 1987; Loughran & Ritter, 1995). SEOs are the

equivalent of an initial public offering (IPO) for firms that are already publicly traded,

4

with the exception of the market already having a history with an SEO issuing firm.

SEOs are steeped in information asymmetry and involve a high degree of information

processing to determine whether the equity price is appropriate, the reasons for pursuing

more capital are justified, and if managers are simply taking advantage of information

asymmetry (Gao & Ritter, 2010; Karpoff, Lee, & Masulis, 2013). Scholars suggest SEOs

are controversial because they are often associated with the perception that managers are

timing the issuance to get capital at equity prices exceeding what the firm is actually

worth, often times despite whether or not managers demonstrate an actual need for the

funds (Cornett & Tehranian, 1994; DeAngelo, DeAngelo, & Stulz, 2010).

I posit that managers can use the language and information contained in the

prospectus that accompanies each SEO to create more favorable capital market reactions

to the issuance. I look at three communication techniques managers may employ to

reduce information asymmetry with investors when undertaking SEOs. First, I expect

managers seek to lower information asymmetry by providing justifications in the ―Use of

Proceeds‖ section of the SEO prospectus. This section of the prospectus is required by

the SEC, and managers are legally bound to provide information about the purpose of

issuing the SEO. Justifications refer to the explicit reasons why the firm is issuing the

SEO. These may include informative reasons such as to pursue growth opportunities,

build new plants, or engage in future acquisitions. These may also include less

informative reasons such as for general corporate purposes or to pay down debt. Second,

I predict managers provide information clarity in the SEO prospectus to try to make the

information less opaque or more ―readable‖ (e.g., Loughran & McDonald, 2014: 1644).

Third, I suggest that managers can use the language in the SEO prospectus to create more

5

favorable organizational images in order to solicit positive perceptions of the firm

(Pfarrer, Pollock, & Rindova, 2010; Rhee & Fiss, 2014).

After introducing these three communication techniques managers can use to

reduce information asymmetry in SEO prospectuses, I then turn to the antecedents

driving when they are apt to use language in each way. I expect that managers are more

or less likely to use this information depending on the competitive environment in which

their firms‘ compete and the corresponding proprietary costs. I integrate a construct from

the competitive dynamics literature referred to as competitive intensity (Barnett, 1997;

Chen & Miller, 2015; Kilduff, Elfenbein, & Staw, 2010). Competitive intensity addresses

managers‘ subjective perceptions of their competition and the perceived propensity for

competitors to react to new information (Barnett, 1997; Kilduff et al., 2010). I contend

that firms with greater levels of competitive intensity are less likely to disclose

proprietary information about their firms, but are more likely to cast a positive

organizational image.

I then examine the outcomes of using information in the SEO prospectus in each

of the three techniques by looking at capital market reactions to the SEO issuance. I

theorize about security analysts‘ reactions because security analysts represent perhaps the

most important information recipient with whom managers interface (Benner &

Ranganathan, 2012; Westphal & Clement, 2008). I posit security analysts will respond

more favorably to the SEO issuance when managers use justifications, increase

information clarity, and/or cast a more favorable organizational image in the SEO

prospectus, particularly because of the controversial nature of the SEO issuance. I gauge

6

security analysts‘ reactions by measuring the number of security analysts downgrading

their recommendations of a firm after an SEO issuance.

Analysts may respond more favorably when managers provide justifications

because they are less skeptical of the firm-related reasons for the issuance and about

managers‘ opportunistic behavior (Karpoff et al., 2013). Analysts may also respond more

favorably when information is clearer. This is because when analysts have a difficult time

processing information about firm events, they respond negatively due to higher

opportunity costs related to additional time and effort spent analyzing that activity

compared to analyzing activities related to several other firms or activities (Hirshleifer &

Teoh, 2003; Lehavy, Li, & Merkley, 2011; Plumlee, 2003). I work from this literature to

further suggest that decreasing information asymmetry is likely insufficient if the

information provided is not clear. I also expect analysts to respond more favorably when

managers use more positive language about the firm (Pfarrer et al., 2010; Rhee & Fiss,

2014).

In this study, I contribute to the literature on voluntary information disclosure,

corporate governance, and competitive dynamics. First, I contribute to voluntary

disclosure theory by examining the antecedents and consequences of voluntary

disclosure. Extant work clearly points to the downsides of disclosing information (i.e.,

proprietary costs), but research has yet to theoretically identify when these proprietary

costs are higher or lower (Healy & Palepu, 2001). As Lang and Sul (2014: 256) point out,

―we know relatively little about the likely prevalence and magnitude of proprietary costs

in practice.‖ Moreover, Beyer et al. (2010: 306) survey literature and conclude that ―there

is no clear empirical evidence to date on how proprietary costs…are related to voluntary

7

disclosures.‖ To remedy this, I build on the competitive dynamics literature to suggest

that proprietary costs are higher when competitive intensity is higher. I expect that

managers issuing SEOs are conscious of the proprietary costs associated with their

announcements. Thus, these differing proprietary costs will increase or decrease the

likelihood of managers disclosing information in the SEO prospectus. In other words, I

connect competitive intensity to actual information disclosure in order to suggest that

competitive intensity relates to proprietary costs.

Second, I contribute to competitive dynamics literature by highlighting a

previously unidentified outcome associated with competitive intensity—voluntary

information disclosure. Finally, I contribute to the literature on corporate governance by

re-examining the decades-old agency theory paradigm involving information asymmetry

and the universal benefits of voluntary disclosure. I suggest that information asymmetry

may represent a necessary component for firms to maintain a competitive edge. I also

contend that managers can make decisions that may appear unpopular to capital market

participants with the intention of concealing proprietary information from competitors.

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CHAPTER 2

LITERATURE REVIEW & THEORETICAL DEVELOPMENT

Information Asymmetry, Agency Concerns, and Controversial Activities

Information asymmetry is the foundation on which agency theory and modern

corporate governance is built (Certo et al., 2003; Finkelstein et al., 2009). Information

asymmetry refers to the differing amounts of information about a firm that managers hold

compared to key stakeholders (e.g., investors, security analysts, media) (Cohen & Dean,

2005). Although difficult to quantify, information asymmetry is greater when managers

know relatively more about the ongoing concerns of their firms than outsiders, and it is

nonexistent in a circumstance where outsiders know exactly what managers do about

their firms (Chan, Menkveld, & Yang, 2008; Connelly et al., 2011). Because of this

information asymmetry, managers may have the ability to act opportunistically (Bebchuk

& Weisbach, 2009; Certo et al., 2003); acting opportunistically refers to managers using

their insider information for their own benefit at the expense of those who have less

information.

Agency theory integrates the concept of information asymmetry to qualify a

formal relationship between the owners of public firms and those who control the actions

and activities of the firms (Eisenhardt, 1989; Jensen & Meckling, 1976). Since the

owners of public firms are conventionally diffuse and diversified, they are often not the

individuals who control the strategic activities of the firms despite the fact that they hold

perhaps the greatest interest in the performance of the firm (Fama & Jensen, 1983b,

1983a). Instead, these owners relinquish control of the firm to managers, who are

expected to dedicate their expertise to maximize the value that the firm may deliver to

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shareholders (Fama & Jensen, 1983a; Jensen, 1986). In this way, managers are the

―agents‖ of shareholders.

Due to the information asymmetry between managers and shareholders in the

agency relationship, shareholders retain a legitimate concern that managers may act

opportunistically (Eisenhardt, 1989; Geletkanycz & Boyd, 2011). Thus, agency theory

addresses conflicts of interest between managers (i.e., controllers) and shareholders (i.e.,

owners) (Eisenhardt, 1989). Consequently, shareholders have instituted several

mechanisms aimed at governing the behavior of managers (e.g., contingent compensation

and boards of directors), such that managers are less able and motivated to act in their

own interests at the expense of shareholders (Daily, Dalton, & Rajagopalan, 2003b).

Referring to these mechanisms as corporate governance, scholars have spent decades

examining agency theory by exploring the efficacy of the techniques and the conditions

under which shareholders are able to minimize the costs associated with managerial

agency (e.g., Bebchuk & Weisbach, 2009; Daily et al., 2003a; Finkelstein et al., 2009).

Despite the intense focus on corporate governance mechanisms from both

scholars and practitioners, there remain several instances when managers may leverage

information asymmetries to act opportunistically. Often times, these instances are types

of activities that allow managers to use their inside information to enhance their own

utility at the expense of shareholders (e.g., Bednar, Love, & Kraatz, 2014; Rhee & Fiss,

2014). Accordingly, these activities are considered controversial. Acquisitions, for

instance, often represent controversial activities because shareholders are potentially

unaware of, or unable to rationalize, the reasons motivating the acquisition itself

(Haleblian et al., 2009; King et al., 2004). Shareholders tend to respond negatively to the

10

acquiring firm announcing an acquisition because they are concerned that managers are

seeking to increase their own power (e.g., Hayward & Hambrick, 1997), may simply

enjoy pursuing other firms (e.g., Kumar, Dixit, & Francis, 2015), or may have personal

characteristics that predispose them to acquiring (e.g., Gamache et al., 2015), amongst

many other reasons that do not involve increasing shareholder value.

Acquisitions represent just one example of how information asymmetries may

make otherwise innocuous strategic activities seem controversial. Other examples may

include growth or expansion (e.g., Brush, Bromiley, & Hendrickx, 2000), issuing

seasoned equity (e.g., Henry & Koski, 2010), CEO board interlocks (e.g., Geletkanycz &

Boyd, 2011), adoption of poison pills (Schepker & Oh, 2013), and stock repurchases

(e.g., Westphal & Zajac, 2001), along with many others. Ultimately, controversial

activities occur when managers could potentially use the activity as a means of

facilitating opportunistic behavior.

When shareholders perceive such activities as controversial, managers who intend

to pursue such activities for the benefit of the firm are faced with a genuine concern. On

one hand, managers may think that pursuing such activities will actually increase the

value of the firm. On the other hand, they face a strong disincentive to pursue these types

of activities because shareholders are skeptical and are likely to respond negatively or

may even terminate the CEO (e.g., Busenbark et al., 2016). In this study, I take the

perspective of managers who are truly trying to increase the value of the firm and must

navigate the disincentives from shareholders that prevent them from doing so. Although I

recognize the importance of corporate governance techniques outlined under traditional

agency theoretic perspectives, in this study I assume that managers are endeavoring to

11

increase firm value and some corporate governance mechanisms may prohibit them from

doing so.

Seasoned Equity Offerings as Controversial Activities

Seasoned equity offerings. Seasoned equity offerings (SEO) represent a method

for firms that are already publicly-traded to issue new shares in exchange for capital

(Autore, Kumar, & Shome, 2008). Sometimes SEOs refer to a mechanism that allows

shareholders to sell large portions of shares on more discrete secondary markets than the

conventional platforms. For example, SEOs can refer to investors selling large portions of

shares through an investment banker rather than through a public stock exchange such as

the New York Stock Exchange. However, the majority of SEO issuances are made by

firms that are seeking additional capital by way of equity rather than debt or other means

(Henry & Koski, 2010; Kalay & Shimrat, 1987). In other words, SEOs both colloquially

and legally represent ―issues of new equity by public firms‖ (Kalay & Shimrat, 1987:

109). Managers issue equity instead of debt to obtain additional capital for a variety of

reasons: debt may be too costly at the time, the firm may be already overleveraged, or the

firm may have additional treasury shares reserved for obtaining capital (DeAngelo et al.,

2010; Mola & Loughran, 2004).

Despite the fact that firms issuing SEOs already have an established price for their

equity, they offer the new equity at a discount in order to attract more investors (Autore,

2011; Mola & Loughran, 2004). Autore (2011) indicates that the average discount

associated with an SEO is approximately 2.5% less than the current share price. Thus, if a

firm‘s stock trades for $10, the seasoned equity price the firm will receive is

approximately $9.75. The primary reason investors require this discount because they

12

could otherwise buy equity on public stock exchanges for the full price. Firms offer a

discount to entice investors to buy new shares.

There are a variety of reasons why firms might issue SEOs. Firms may need more

capital to pursue expansion of production plants, open new retail outlets, capitalize new

strategic alliance ventures, hire more employees, restructure the capitalization of the firm

(e.g., pay down debt), pursue acquisitions, or maintain generally desirable levels of

liquidity (Autore et al., 2009; Cornett & Tehranian, 1994). Ultimately, when firms need

capital to pursue strategic activities, and receiving that capital via the issuance of new

debt is less desirable than by issuing new equity, firms are apt to issue SEOs. Masulis and

Korwar (1986: 91), for example, describe the fundamental rationale underlying why

firms may elect to issue seasoned equity by suggesting firms may ―finance capital

expenditures‖ and ―lower the firm‘s leverage‖.

The process of issuing an SEO is both similar to, and somewhat different than, its

newly-public analog of initial public offerings (IPO). SEOs are similar to IPOs in that

both require prospectuses to identify characteristics of the firm as well as the intended use

of the proceeds from the equity issuance (Certo, 2003; Gao & Ritter, 2010; Heron & Lie,

2004). Even though firms issuing SEOs do have a track record and verified performance

history with shareholders, whereas firms issuing IPOs do not (Certo, 2003; Certo,

Holcomb, & Holmes, 2009), the prospectus is a necessary tool for investors to understand

essential characteristics of the firm and how additional capital may manifest in stronger

future performance. Thus, an important element of an SEO prospectus is a mandatory

section referred to as the ―Uses of Proceeds‖ section. In this section, managers can

13

communicate why their firms need capital in exchange for equity (Autore, 2011; Autore

et al., 2009).

SEOs are also often associated with less information asymmetry than IPOs since

investors have had a period of time to monitor an issuing firm‘s performance and have an

auditing history when the firm is already public (Heron & Lie, 2004). Because of this,

SEOs often release new equity in several stages rather than in a grandiose event like an

IPO (Autore et al., 2008; Gao & Ritter, 2010; Heron & Lie, 2004). This is referred to as a

shelf-offering (SEC Rule 405-b), wherein firms can issue several rounds of equity using a

single prospectus (Autore et al., 2008; Heron & Lie, 2004). Since a single prospectus can

apply to several issuances of new equity, the prospectus associated with the first

announcement of an SEO issuance is highly scrutinized by investors and security

analysts.

SEOs as controversial activities. Despite the fact that SEOs are associated with

already public firms, are approved by the board of directors, and are accompanied by a

regulated document that details why the firm is raising capital, SEOs often solicit

negative stock market-related outcomes (Henry & Koski, 2010; Loughran & Ritter, 1995;

Mola & Loughran, 2004). Decades of research in the finance and accounting literatures

has documented how SEOs are often accompanied by negative stock market reactions to

the announcement of the issuance (e.g., Henry & Koski, 2010) and by abnormally low

post-issuance operating performance (e.g., Eberhart & Siddique, 2002). By and large,

scholars in these literatures have offered two overarching reasons for these negative

outcomes associated with SEOs, both of which stems from information asymmetry and

the corresponding costs that agency theory would predict.

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First, scholars suggest that since managers have more information about the

operations and future prospects of their firms than do investors, they could time SEO

issuances to occasions when the share price of the firm is higher than they believe it is

actually worth (Corwin, 2003; DeAngelo et al., 2010; Loughran & Ritter, 1995). As

DeAngelo et al. (2010: 275) suggest, ―market timing appears to have a statistically

significant influence on the decision to conduct an SEO.‖ In other words, managers may

wait until the stock market has optimistically valued their firms‘ shares in order to issue

equity to receive the highest possible value for it. Corwin (2003) suggests that the

uncertainty that investors face about managers‘ using their asymmetric information in

this way may influence the negative reactions to SEOs.

Second, some scholars suggest that managers engage in an unsustainable use of

discretionary accruals around SEO issuances in order to make their firms‘ financials and

prospects appear better than they actually are (DeAngelo et al., 2010; Teoh, Welch, &

Wong, 1998). The argument is that managers may use ―unusually aggressive

management of earnings through income-increasing accounting adjustments [to lead]

investors to be overly optimistic about the issuer‘s prospects‖ (Teoh et al., 1998: 63). In

other words, these scholars again assume managers use information asymmetry to their

advantage in order to manipulate investors who ―naively extrapolate pre-issues earnings

without fully adjusting for the potential manipulation of reported earnings‖ (Teoh et al.,

1998: 63). Thus, these scholars argue that some investors are skeptical of managers‘ use

of discretionary accruals and thus may engage in heavy short selling around the issuance

of the SEO (Henry & Koski, 2010).

15

Whether or not managers actually engage in these types of behaviors, however, is

both difficult to determine and largely irrelevant to scholars who perceive managerial

behavior through the lens of traditional agency theory. Indeed, scholars suggest that just

the uncertainty associated with managers using information asymmetries to their

advantage is enough to encourage many investors to act skeptically (Corwin, 2003;

Karpoff et al., 2013). Further, given the alternatives managers could use to raise capital,

investors are often skeptical about why managers selected an SEO.

Investors may also respond negatively to SEOs on the basis of information

asymmetry and earnings per share (EPS) dilution. SEOs represent a dilutive activity for

existing shareholders (Kalay & Shimrat, 1987; Spiess & Affleck-Graves, 1995). Unless

an issuance of new shares of equity is accompanied by a corresponding earnings increase,

the EPS for the company decreases. Shareholders tend to dislike dilutive activities and

reactive negatively when managers engage in activities that dilute the firm‘s EPS (Huson,

Scott, & Wier, 2001; Martin, 1996). Brisker et al. (2014) suggest that managers issuing

SEOs can minimize dilution by adding value with the information they provide in the

SEO prospectus. For examples, managers can demonstrate how the cash received from

the SEO will result in productive future activities, thereby offering inside information

about the firm and decreasing information asymmetry. Without providing such

information, investors are left to question managers‘ intentions for the SEO issuance and

why their shares are being diluted.

SEOS tend to receive negative responses from capital market participants despite

the fact that SEOs issued by firms publicly trading on American stock exchanges are

approved by the board of directors (Holderness, 2016; Holderness & Pontiff, 2016). This

16

is in contrast to firms in several other countries whose shareholders participate in a vote

any time new equity is issued (Holderness & Pontiff, 2016). Myers and Majluf (1984)

suggest that agency concerns stemming from information asymmetry are often lower

when the board approves new equity issues than when the board does not because

directors are meant to represent shareholders. However, Holderness (2016) points out that

the overwhelming majority of evidence suggests that investors‘ concerns over managerial

opportunism during SEO issuances are not assuaged by the fact that the board authorizes

the issuance. Holderness and Pontiff (2016) suggest this is the case because very few

shareholders are involved with and interested in judiciously monitoring the firm and its

board of directors. Board approval of SEO issuance does little to satiate the average

investor.

Negative capital market reactions to SEO issuances represent a real problem for

managers who genuinely need to pursue SEOs. By this, I am referring to managers who

are issuing SEOs for the purposes of using the corresponding capital to finance future

strategic activities. While some managers may issue an SEO to capitalize on

overvaluation of the firm‘s share price, other managers may not have the necessary

capital to pursue value-creating future strategic activities (Autore et al., 2009; DeAngelo

et al., 2010). For managers in the latter scenario, this presents an impediment to securing

the necessary capital to pursue activities.

Consistent with the tension I outlined in the above section, SEOs represent such

activities that managers may need to pursue but where they face strong disincentives to

do so. Investors dislike SEOs almost regardless of the necessity for them (e.g., Cornett &

Tehranian, 1994). For these reasons, I suggest SEOs represent controversial activities.

17

Rhee and Fiss (2014: 1735) conceptualize controversial activities as those when ―the

meaning of which is uncertain and which could potentially be aligned with either a

dominant logic or opposing arguments.‖ Put differently, controversial activities are those

which may receive positive or negative outlooks depending on the perspective of the

individual(s) analyzing the activity (Fiss, Kennedy, & Davis, 2012; Rhee & Fiss, 2014).

In the coming sections, I will take the perspective of a manager who is pursuing

an SEO for the intended purposes of maximizing shareholder value and not for the

purposes of leveraging information asymmetries to take advantage of shareholders.

Following recent work in the management literature (e.g., Fiss et al., 2012; Fiss & Zajac,

2006; Rhee & Fiss, 2014; Washburn & Bromiley, 2013), I will argue that managers can

use the asymmetric information they hold in a variety of ways to decrease the perception

that their SEO is controversial. If managers can do so, they may make the SEO either

seem less controversial or may improve reactions to the announcement of the SEO

issuance.

Proprietary Information as a Strategic Mechanism

Although agency theory-related perspectives may suggest information asymmetry

is an impediment to maximizing firm value (e.g., Eisenhardt, 1989; Fama & Jensen,

1983b; Jensen & Meckling, 1976), it is also an important characteristic of the public firm

to ensure those individuals with strategic discretion are the most informed on the ongoing

activities of the firm (Crossland & Hambrick, 2011; Fama & Jensen, 1983a). Managers‘

ability to use their insider information to their advantage is an important element in the

performance of the firm (Crossland & Hambrick, 2007). Arguing that successful use of

insider information is a function of envisioning different strategic alternatives for the

18

firm, Crossland and Hambrick (2011: 799) suggest ―some executives are able to envision

or create more alternatives than are others, due differing degrees of creativity, locus of

control, or other personal attributes.‖ In other words, the ability of managers to use their

inside information is paramount to improving firm value.

One way managers can use their inside information to improve firm value

involves voluntary disclosure. Voluntary disclosure refers to instances where managers

leverage their discretion to time the release and vary the content of insider information to

outsiders (Healy & Palepu, 2001). Whereas some information mandates disclosure (e.g.,

financial statements, auditing reports, share price asked in SEO prospectuses), other

information is disclosed voluntarily or at managers‘ discretion (e.g., strategic initiatives,

CSR activities, future strategic activities, future earnings projections). This discretion is

especially important when it involves material information, which refers to information

that is substantive and potentially critical to the firm and its activities (Cohen & Dean,

2005). Accounting scholars note that managers must disclose material information, as

mandated by the SEC, since this information informs stock prices (DeAngelo, 1988; Ge

& McVay, 2005; Skinner, 1997). These scholars notice that managers exercise some

discretion, however, over when they disclose potentially material information, which

refers to information about events that may occur but have not yet; managers also

maintain discretion of over non-material information (DeAngelo, 1988; Skinner, 1997).

Voluntary disclosure theory predicts that managers will choose to disclose such

insider information when the perceived benefits from disclosure outweigh the perceived

costs (Guidry & Patten, 2012; Lewis et al., 2013; Verrecchia, 1983). At its core,

voluntary disclosure theory is about how managers exercise their discretion to decide

19

when to release insider information and what insider information they may release. Even

when managers face mandates to release more or less information, scholarship on

voluntary disclosure suggests managers still possess some discretion of the timing of the

information, the mode in which it is released, and the way in which it is released (Healy

& Palepu, 2001; Lewis et al., 2013).

Research has examined managers‘ discretionary use of insider information under

the lens of voluntary disclosure theory (e.g., Beyer et al., 2010; Healy & Palepu, 2001;

Li, 2010). In much of this research, scholars suggest that managers are concerned about

meeting or beating earnings forecasts from security analysts. Thus they may choose to

release insider information prior to their formal earnings announcement in order to help

analysts and investors arrive at an estimate for future earnings that aligns with what

managers expect their firms can achieve (Baginski, Conrad, & Hassell, 1993; Beyer et al.,

2010; Washburn & Bromiley, 2013). Of course, managers may disclose other types of

information besides that which relates directly to earnings. Managers may disclose

information about environmental impact (e.g., Lewis et al., 2013), future strategic

initiatives (e.g., Frankel, Johnson, & Skinner, 1999), the CEO (e.g., Chen et al., 2014), or

the general going activities within the firm (e.g., Graffin et al., 2016), amongst many

other aspects of the firm.

There are at least three different theoretical perspectives regarding information

disclosure, why managers choose to disclose information, and the rationale behind

potential benefits. First, agency theory predicts managers will disclose information to

reduce information asymmetry between themselves and outsiders (namely investors or

security analysts) (Beyer et al., 2010). This is to suggest that voluntary disclosure of

20

inside information exists to decrease information asymmetry at times managers deem

opportune. Second, voluntary disclosure theory predicts that managers will disclose

information that benefits outsiders who managers want to use the information, as long as

those benefits outweigh the costs of other individuals accessing the information (Lewis et

al., 2013; Verrecchia, 1983). This suggests that managers may consider what and how

information is communicated. More specifically, managers are selective over the

language they use to communicate information to outsiders (Lehavy et al., 2011;

Loughran & McDonald, 2011); managers want to ensure the information is ―coherent and

comprehensible‖ (Rindova, Pollock, & Hayward, 2006: 56). Third, impression

management theories suggest that managers may release information to make their firms

appear more positive or more favorable to outsiders (Washburn & Bromiley, 2013). In

other words, managers want to frame information to help external audiences believe there

is value in the ongoing activities.

In the coming sections, I argue that managers may use information contained in

the SEO prospectus in three different ways, consistent with the three theoretical

rationales underlying discretionary information disclosure. I suggest that managers may

use justifications in order to help decrease information asymmetry, may use information

clarity in order to ensure the language is coherent and comprehensible such that it is

interpreted and processed the way managers intended, and may cast a positive

organizational image in order to manage impressions about the firm.

Justifications. Agency theory predicts a negative relationship between the

information asymmetry a manager holds and the type of reactions an outsider (e.g.,

shareholder, security analyst) would have to any given strategic event or announcement

21

of information (Daily et al., 2003b; Finkelstein et al., 2009; Healy & Palepu, 2001).

When information asymmetry is lower, stock market participants tend to respond more

favorably to strategic announcements (Certo et al., 2003; Zhang, 2006a, 2006b).

According to extant theory relating to SEOs, stock market participants tend to respond

negatively to SEO announcements because of the inherent information asymmetry;

however, these same participants tend to respond less negatively or positively when

managers are able to decrease information asymmetry associated with the SEO issuance

(Cornett, Mehran, & Tehranian, 1998; Cornett & Tehranian, 1994). Cornett and

Tehranian (1994) suggest that firms are able to receive better stock market reactions to

SEOs when investors are able to identify and rationalize why the firm is issuing equity.

I argue that managers are able to create justifications in the SEO prospectus with

the intention of reducing outsiders‘ perceived information asymmetry (e.g., Gao et al.,

2016; Porac, Wade, & Pollock, 1999). The use of justifications refers to ―creating

inductive analogical and metaphorical reasoning supporting‖ the rationale underlying the

SEO issuance (Cornelissen & Clarke, 2010: 539). Justifications may also refer to

explanations for behavior (Shaw, Wild, & Colquitt, 2003; Staw, McKechnie, & Puffer,

1983). Further, it may allow outsiders to compare information from the firm to their own

expectations or to other firms (Porac et al., 1999; Zajac & Westphal, 1995). The use of

justifications allows outsiders to create reasons, explanations, and rationale for a firm‘s

activity, thereby decreasing the uncertainties from information asymmetry that would

have otherwise existed without those justifications (Lechner & Floyd, 2012).

Consistent with agency theory, I suggest managers may use justifications about

the SEO to decrease the information asymmetry observers may attribute to the SEO

22

issuance. Managers may justify the SEO issuance by describing the purpose of the SEO

in the ―Uses of Proceeds‖ section of the accompanying prospectus. Whereas some

managers may not provide any useful information in the ―Uses of Proceeds‖ section,

other managers may seek to justify the SEO by identifying one or many reasons for

which the firm needs the associated equity. Some managers may provide ambiguous

justification for the SEO issuance (e.g., ―general corporate purposes‖), while other

managers may explicitly state specific activities the firm may use the capital to pursue

(e.g., ―acquisitions‖, ―new plant expansion‖). In doing this, managers decrease the

quantity of information asymmetry between themselves and outsiders.

Managers may also use justifications in the SEO prospectus to help outsiders

make sense of the activities the firm is undertaking. When firms conduct potentially

controversial activities, outsiders are left to rationalize the activities in accordance with

what they believe the firm is doing—this often works to the detriment of managers

because outsiders tend to focus on the potential agency costs and possibility of

opportunistic behavior (Rhee & Fiss, 2014; Zajac & Westphal, 1995). However, if

managers use justifications, they can create what capital market participants perceive as

―appropriate rationales‖ for the activity (Zajac & Westphal, 1995: 285). In the case of

SEO issuances, appropriate rationales likely represent informative reasons for the SEO

issuance beyond capitalization on overvaluation. Rhee and Fiss (2014) connect this idea

of justifying controversial activities to sensegiving, which refers to helping others to

make sense of and construct meaning about activities. They suggest that how managers

justify controversial activities is an important determinant of outsider perceptions of the

23

activity because justifications help outsiders create sense about the activity. Such

perceptions of justifications are exceedingly important when the activity is controversial.

Information clarity. In accordance with voluntary disclosure theory, scholars

suggest one reason managers may choose to release information is to shape outsiders‘

cognitions or interpretations of the firm in specific ways (Dhaliwal et al., 2011; Guidry &

Patten, 2012). Other scholars have conceptualized this by suggesting information can

help craft a story for outsiders to perceive information in ways the authors (e.g.,

managers) intended (Rindova et al., 2006). In order for managers to release information

that will successfully craft a story or get interpreted in the ways they intend, the

information needs to possess qualities consistent with it being cogent, coherent,

comprehensible, and easy to process (Lehavy et al., 2011; Loughran & McDonald, 2014;

Rindova et al., 2006).

In other words, managers need to engage in information clarity. Whereas the use

of justifications integrates work that builds on agency theory to suggest that providing

more information about a firm may reduce information asymmetry (e.g., Rhee & Fiss,

2014), information clarity focuses on the way that information is communicated. I am

referring to information clarity as how easily the information is consumed by readers, and

thus how easily it is processed.

Recognizing the need for information clarity, recent scholarship in the finance

literature has examined the ―readability‖ of information and how this might distil into the

ways outsiders interpret the information (e.g., Lehavy et al., 2011; Loughran &

McDonald, 2011; Loughran & McDonald, 2014: 1643). Readability addresses the ―Plain

English‖ standards for language and does so using a grade school level understanding of

24

how easy a document is to read (Kimble, 1994; Loughran & McDonald, 2014). Scholars

in this literature suggest that outsiders may have a difficult time processing, interpreting,

and understanding opaque or poorly written documents; in these cases, outsiders are

unable to follow the story the managers craft with the information (whether that story

involves communicating financials, strategic activities, or other more complex elements)

(Lawrence, 2013; Lehavy et al., 2011). In fact, Lehavy et al. (2011) suggest that

documents that are too difficult to read are essentially unusable because outsiders are

unable to correctly interpret the information contained within them.

Scholars have suggested that communicating information clearly is a skill that

some managers possess and other managers do not (Kimble, 1994). Lehavy et al. (2011)

suggest that this skill is especially important when the information is non-standardized or

more complex. This is the case for SEO issuances, which can fall outside the realm of

highly scripted documents such as financial statements (Dougal et al., 2012; Lawrence,

2013; Lehavy et al., 2011). Communicating such complex information clearly is

associated with several benefits, including better stock market reactions, better analyst

reactions, and favorable press coverage (e.g., Dougal et al., 2012; Hirst & Hopkins, 1998;

Lawrence, 2013; Lehavy et al., 2011).

There are two highly related reasons to explain why managers may prefer to

present information clearly in public documents. Each of the two reasons is built on the

idea that when information contained in documents is clearer, outsiders have to spend

less time and effort processing the information (Lehavy et al., 2011; Loughran &

McDonald, 2014). First, this translates into lower opportunity costs for outsiders

associated with doing other activities, such as evaluating other firms, investing in other

25

firms, or conducting other activities to increase their utility (Hirshleifer & Teoh, 2003;

Lou, 2014; Plumlee, 2003). Second, information that is more difficult to process invokes

higher costs of gathering information (Rindova et al., 2006; Washburn & Bromiley,

2013). Scholars have found that outsiders dislike having to expend additional effort

gathering information to evaluate what they have been provided, which is referred to as

―costs‖ associated with gathering information (Aldrich & Fiol, 1994; Washburn &

Bromiley, 2013: 854).1

In sum, managers may provide clearer information in SEO prospectuses in order

to help craft a cogent story to outsiders, to decrease information processing time, and to

decrease costs associated with gathering and analyzing information (Hirshleifer & Teoh,

2003; Rindova et al., 2006; Washburn & Bromiley, 2013). To do so, managers may use

simpler language (e.g., Kimble, 1994), shorter sentences (e.g., Loughran & McDonald,

2014), concise document structures (e.g., Lawrence, 2013), or more familiar business

nomenclature (e.g., Loughran & McDonald, 2011). I suggest that all of these tactics

represent information clarity.

Casting a positive organizational image. Managers may provide information

about their organization to create a more favorable or positive perception of the image of

the organization (Elsbach & Sutton, 1992; Gao et al., 2016; Rhee & Fiss, 2014). In other

words, managers may cast a positive organizational image in order to improve the

perceptions of the organization or to prevent image-threatening activities (such as SEOs)

1 Some scholars have also suggested that managers may intentionally communicate unclearly in order to

distract outsiders or to obfuscate information (e.g., Graffin et al., 2011). While this remains a possibility, I

do not expect it to occur within the SEO prospectus because of the legal ramifications of issuing

intentionally misleading information in the document. Perhaps managers may seek to obfuscate the

information in the SEO using other information mediums, but this is outside of the scope of my study.

26

from creating negative perceptions of the organization (Fiss & Zajac, 2006; Rhee & Fiss,

2014; Staw et al., 1983). Scholars suggest this technique is important because certain

activities may threaten the image of an organization and thereby cause negative outcomes

such as reduced legitimacy, reputation, and status (e.g., Bednar et al., 2014; Bitektine,

2011; Deephouse & Suchman, 2008; Gao et al., 2016). Managers may provide positive

information about their firms in order to help offset those negative outcomes (Bansal &

Clelland, 2004; Graffin et al., 2016; Washburn & Bromiley, 2013).

Casting a positive organizational image involves selectively disclosing positive

information about the firm, even if it is not necessarily novel or related to a focal event

(Elsbach & Sutton, 1992; Graffin et al., 2016; Washburn & Bromiley, 2013). Managers

may frame information about the firm in such a way that it creates more favorable

perceptions of the organization even if the framing of that information is not relevant to

the situation at hand (e.g., SEO issuances) (e.g., Benner & Ranganathan, 2012; Westphal

& Zajac, 2001). Appropriately, I draw from framing theory (e.g., Cornelissen & Clarke,

2010; Fiss & Zajac, 2006) and impression management research (e.g., Graffin et al.,

2016; McDonnell & King, 2013) to explain why and how managers may cast a positive

organizational image.

Framing theory suggests that managers can provide information in such a way

that observers‘ attention is directed toward positive facets of an organization (Cornelissen

& Clarke, 2010; Cornelissen & Werner, 2014). Put differently, managers can frame the

information they provide to influence the cognitions of outsiders and to direct them

towards desirable facets of the organization or more favorable lenses through which the

information is viewed (Benner & Tripsas, 2012). To do this, managers may project

27

certain information about the organization to influence a more favorable cognitive frame

from those consuming the information (Cornelissen & Werner, 2014; Gavetti, Levinthal,

& Rivkin, 2005). As Fiss and Zajac (2006: 1174) identify, managers may frame by

―articulating a specific version of reality, [thereby securing] both the understanding and

support of key stakeholders…because it shapes how people notice and interpret what is

going on.‖ Managers can focus on positive aspects of the organization in order to help

outsiders perceive the potentially controversial activity of an SEO more favorably.

Framing outsiders‘ perceptions of the firm via casting a positive organizational

image is also tied to theories of impression management. Impression management refers

to managers releasing information to ―influence outsiders‘ perceptions of their firms‖

(Bansal & Clelland, 2004: 95). As Bansal and Clelland (2004) point out, managers may

release such information in mediums such as shareholder meetings, annual reports, public

documents, and press releases. Therefore, managers may use the SEO prospectus as an

opportunity to provide selective information about the organization to encourage

outsiders to perceive the organization more favorably. This is consistent with the

foundations of impression management research, which ―typically assumes managers of

firms want to build positive impressions‖ of their organizations (Washburn & Bromiley,

2013: 850). Further, some impression management scholarship suggests that managers

apt to focus on positive aspects of the organization rather than negative or defensive

language because observers tend to respond favorably to positive language and

unfavorably to negative language (Graffin et al., 2016; Hovland, Janis, & Kelley, 1953).

I suggest managers may selectively disclose positive information about their

organizations to influence outsiders‘ perceptions of their firms. This will work to manage

28

impressions about what is often otherwise considered as a negative and controversial

activity of an SEO issuance. Following framing theory and impression management, I

suggest managers may frame the SEO in a positive light by speaking positively about

aspects of their organizations with the intention of influencing outsiders to perceive the

organization more favorably (Graffin et al., 2016; Rhee & Fiss, 2014; Washburn &

Bromiley, 2013).

This is not to suggest casting a positive organizational image is a costless

endeavor. Indeed, discussing the firm positively introduces potentially unnecessary

language into the prospectus, which may conflict with clearly communicating the

purposes of the SEO issuance—something I discuss in the coming sections that security

analysts tend to dislike (Lehavy et al., 2011; Litov, Moreton, & Zenger, 2012). Further,

outsiders may perceive managers‘ positive sentiments about their organizations as

inauthentic or disingenuous, particularly if the organization is performing poorly.

Research on ―cheap talk‖ suggests that such instances undermine otherwise credible

information that managers are attempting to convey (Almazan, Banerji, & Motta, 2008;

Connelly et al., 2011; Whittington, Yakis‐Douglas, & Ahn, 2016).

29

CHAPTER 3

THEORY & TESTABLE HYPOTHESES

Proprietary Costs and Competitive Dynamics – Antecedents

Voluntary disclosure theory suggests that managers will disclose non-required

information about the firm when the benefits of doing so outweigh the costs (Guidry &

Patten, 2012; Lewis et al., 2013). Previously, I posited that managers may use their

discretion to voluntarily disclose information in at least three ways—justifications,

information clarity, and casting a positive organizational image. In this section, I turn to

the potential costs associated with voluntarily disclosing such information. I integrate

research in competitive dynamics to examine the role of competitive intensity (Barnett,

1997; Kilduff et al., 2010) in understanding when managers are likely to disclose inside

information.

Proprietary costs. Proprietary costs represent perhaps the most significant force

that influences the degree to which managers reveal inside information (e.g., Healy &

Palepu, 2001; Verrecchia, 1990b). Proprietary costs refer to any performance losses a

firm would receive from competitors having access to inside information (Lang & Sul,

2014). In other words, proprietary costs are greater when competitors can achieve a

stronger competitive edge by knowing information that is otherwise reserved only for

those individuals inside the information-revealing organization (Ali, Klasa, & Yeung,

2014). Proprietary costs build on the ideas of material proprietary information.

Proprietary information is information about the firm that insiders possess and outsiders

do not (Healy & Palepu, 2001). While proprietary costs refer to harm from releasing that

30

information, these costs generally assume that the information released is material or

important to the performance of the firm.

At its core, the concept of proprietary costs is focused on competitors, what they

know, what they do not know, and how they might use internal information against a firm

that is disclosing information (e.g., Beyer et al., 2010; Ellis, Fee, & Thomas, 2012; Lang

& Sul, 2014). Thus, proprietary costs represent a different type of information asymmetry

than asymmetry between managers and investors. Proprietary costs are borne out of

information asymmetry between managers of a focal firm and managers of its

competitors (Beyer et al., 2010; Healy & Palepu, 2001). This distinction is important

because the information asymmetry between firms and their rivals is often qualitatively

and quantitatively different than asymmetry between managers and investors. Rival firms

may know more or less about the inside information of a firm than do its investors.

Further, there is likely different relative value of this information between rivals or

investors of a focal firm. Proprietary costs involve the information asymmetry between

firms and their rivals.

When firms face higher proprietary costs and disclose too much information, they

are at risk of competitive declines and destroying firm value (Ellis et al., 2012). In fact,

proprietary costs are an important element of the sustained competitive advantage firms

can achieve from their internal resources. As conceptualized by Barney (1991) and the

scholarship building on the resource based view of the firm, organizations hold a

competitive advantage when competitors are unable to decipher and imitate or mitigate

the value-creating resources the organization holds (i.e., causal ambiguity) (Reed &

DeFillippi, 1990). For this reason, managers must consider the potential for competitors

31

to leverage any information that managers may publically disclose (Ellis et al., 2012;

Verrecchia, 1990b).

Proprietary costs are often connected to the competitive landscape of the firm

considering information disclosure. Much of the work investigating these costs has

almost exclusively posited a positive relationship between industry concentration and

proprietary costs (Beyer et al., 2010; Lang & Sul, 2014; Li, 2010). The logic is that as

industries become more concentrated, there is a greater threat of existing rivals using new

information to enter the product or innovation market of the disclosing firm (Li, 2010).

Scholars in this area suggest that proprietary costs are characterized by rivals reacting to

information and then using that new information to enter into the product markets of the

firm disclosing information (Ali et al., 2014; Beyer et al., 2010; Li, 2010).

Inconclusive findings. Aside from industry concentration, however, there have

been few theoretical and empirical inroads conceptualizing and quantifying when

proprietary costs are higher or lower (Beyer et al., 2010; Healy & Palepu, 2001; Lang &

Sul, 2014). In fact, even recent scholarship examining the link between industry

concentration and proprietary costs has suggested that the evidence supporting a positive

relationship between industry concentration and proprietary costs is mixed and

inconclusive (Beyer et al., 2010; Lang & Sul, 2014). In this scholarship, industry

concentration is typically measured using the Herfindahl Index or other similar measures

that calculate the competitive density of an industry (Ali et al., 2014; Lang & Sul, 2014).

There are four potential explanations for the inconclusive relationship between

industry concentration and proprietary costs. First, using industry concentration

essentially imputes an identical value for proprietary costs for all firms in a given

32

industry or segment over each year, unless a remarkable shake-up changes the structure

of the firms in the industry (e.g., Ali et al., 2014; Lang & Sul, 2014). This is too broad to

capture the actual competitive forces that may influence managers‘ proclivity to disclose

proprietary information. Second, this conceptualization relies on the assumption that

firms have, on average, a greater likelihood of responding to new information when the

industry is more concentrated. There is, however, no underlying theoretical rationale to

suggest that firms in more concentrated industries have a greater propensity to respond to

information (Chen, 1996; Lang & Sul, 2014).

Third, this scholarship has not focused on what represents actual concerns for

managers. Instead, it has focused on whether or not competitors will enter into the same

markets (product or otherwise) as the disclosing firm (Ali et al., 2014; Bamber & Cheon,

1998), but not whether managers will care about those types of activities. Indeed,

managers‘ concerns may focus on processes, capabilities, activities, or knowledge-bases

that they perceive as key resources. In other words, concerns over competition may

extend beyond simply entering or exiting from markets. Finally, and perhaps most

importantly, industry concentration does not address managers‘ perceptions of

competition. Since voluntary information disclosure is an endogenous choice managers

make (Lewis et al., 2013; Verrecchia, 1983, 1990b), their perceptions of the cost of doing

so are likely idiosyncratic and highly subjective.

To help resolve the problems associated with conceptualizing proprietary costs

using industry concentration, I suggest an approach that scholars suggest may more

accurately capture managers‘ concerns over competitive actions (Chen & Miller, 2012;

Chen & Miller, 2015). Following work in the competitive dynamics literature, I postulate

33

it is perhaps more appropriate to focus on how firms in a competitive landscape are

actually behaving rather than their relative sizes (which is what the industry concentration

approach employs) (Yu & Cannella, 2013). Specifically, I expect that when there is more

competitive activity in an industry, rivals have a greater propensity to respond to new

information. When rivals have a greater propensity to respond, they are likely to react to

proprietary information and use that information for their benefit. This is something

information-disclosing managers may directly consider when providing inside

information to outsiders.

To investigate this more activity-centric conceptualization, I utilize the core tenets

held within the competitive dynamics literature. This literature has a long history of

recognizing the competitive landscapes and actions of firms instead of looking broadly at

the environment (e.g., Baum & Korn, 1996; Chen & Miller, 2012; Yu & Cannella, 2013).

In this literature—which is largely held within the confines of management scholarship—

the competitive forces which influence managerial behavior often arise from actions that

competitors and focal firms take (Chen, Kuo-Hsien, & Tsai, 2007). Instead of focusing

on passive elements of an industry structure (like the density of the industry), I suggest it

is more appropriate to focus on the activities of the firms in an industry and how they

change over time (Grimm, Lee, & Smith, 2005). For example, new product introductions

by firms in a market may inform managers as to how competitively active a market is

compared to simply looking at the general market density of the industry.

Competitive intensity. Competitive intensity, which addresses the interactions

between a firm and its close set of rivals, is a key theoretical framework in the

competitive dynamics literature (Barnett, 1997; Giachetti & Dagnino, 2014). Competitive

34

intensity builds on the framework of ―intensity of rivalry‖ proposed in Porter‘s (1979)

Five Forces model in order understand how small clusters of firms‘ actions are shaped by

concerns over competitors‘ responses. Competitive intensity is conceptualized as the

perceived ferocity of competition between either two rivals or a small set of rivals (Chen

et al., 2007; Kilduff et al., 2015; Kilduff et al., 2010). Competitive intensity represents a

perceived breaking point at which managers believe their competitors may use

competitive tactics against their firms (Chen et al., 2007).

Using sports as an analogy, Kilduff et al. (2010) suggest that competitive intensity

between a firm and its rivals is similar to the intensity of rivalry between sports teams;

there is a winner and loser (i.e., it is a zero sum game), and both parties use available

information to interpret and react to moves by the opposing party in order to improve the

likelihood of winning. Similarly, Barnett (1997: 130) defines competitive intensity as

―the magnitude of effect that an organization has on its‘ rivals life chances [of

survival]...[and] the probability of competition [that] varies from market to market.‖

Under weak competitive intensity, a focal firm is not as concerned about a rival harming

performance as under strong competitive intensity (Barnett, 1997).

There are three related conceptual characteristics of competitive intensity that

may help explain proprietary costs and managers‘ corresponding inclination to disclose

proprietary information. First, competitive intensity is relational, meaning that it involves

managers‘ evaluations of rivals (e.g., Kilduff et al., 2010). Specifically, Kilduff et al.

(2010: 945) suggest that a rivalry between firms is ―a subjective competitive relationship

that an actor has with another actor that entails increased psychological involvement and

perceived stakes of competition for the focal actor, independent of the objective

35

characteristics of the situation.‖ Whereas a sizeable portion of the extant literature on

proprietary costs focuses on objective industry-related characteristics (e.g., Ali et al.,

2014; Li, 2010), competitive intensity recognizes a subjective and perceptual rivalry

between two (or a small set of) firms. Similar to the concept of competitive asymmetry

(Baum & Korn, 1999), competitive intensity recognizes some managers are more

concerned about competitors responding to proprietary information than other managers.

Kilduff et al. (2010) suggest managers perceive greater levels of intensity when rival

firms are more similar, when firms have repeated interactions, and when managers think

the stakes are relatively high. Ultimately, there is a psychological component integrated

in competitive intensity, such that managers are inclined to withhold proprietary

information due to the fear of rivals ―winning‖ (Chen & Miller, 2015; Kilduff et al.,

2010; Tauer & Harackiewicz, 2004; Zajonc, 1968).

Second, competitive intensity directly addresses rivals‘ propensity to respond to

new information (e.g., Gimeno & Woo, 1999). Competitive intensity is greater when

rivals are able to extract rents, decrease performance, or undermine the sustained

competitive advantage of a focal firm (Gimeno & Woo, 1996, 1999). Indeed, competitive

intensity considers the ―competitive interaction within focal-market rivals, and it is

therefore influenced by the competitive behavior of those rivals‖ (Gimeno & Woo, 1999:

242). When competition is more intense, rivals react quicker and with greater ferocity to

new information (Baum & Korn, 1996; Boeker et al., 1997; Young, Smith, & Grimm,

1997). In other words, rivals‘ propensity to respond to strategic actions (e.g., new

information) is almost synonymous with competitive intensity. Connecting this to

proprietary costs, I suggest that firms competing more intensely with rivals are subject to

36

faster and greater competitive responses when releasing information. Thus, when

competitive intensity is higher, potential proprietary costs are higher.

Finally, competitive intensity is time variant, such that there is a fluid and

evolving trigger-response sequence between competitors (e.g., Barnett, 1997). At its core,

competitive intensity focuses on the moves and countermoves of rivals over an extended

period of time (Chen & Miller, 2015; Yu & Cannella, 2007). Using a density-dependent

model, Barnett (1997) conceptualizes competitive intensity within the confines of

organizational ecology. In doing so, competitive intensity is perceived as a temporally

indefinite construct wherein any specific moment of intensity represents both an

accumulation of triggers and actions and a subjective evaluation of position within a

competitive ecology. Over time, as competitive intensity increases and decreases, firms

enter and exit in their markets due to rivals acting and responding to triggers (Baum &

Korn, 1996). In the case of proprietary information, competitive intensity may represent

proprietary costs more or less depending on the recent interactions between firms.

Each of these three related characteristics of competitive intensity represents

differences from industry concentration as a conceptualization of proprietary costs.

Whereas industry concentration is objective and rigid, competitive intensity is relational,

fluid, and represents asymmetrical abilities to use new information competitively.

Competitive intensity also allows for the conceptualization of managerial choice—which

is a primary characteristic of voluntary disclosure (Healy & Palepu, 2001; Verrecchia,

1990b). As competitive intensity shifts over time and as managers perceive these shifts

differently, proprietary costs may increase or decrease. Therefore, perceptions of

competitive intensity over time may influence proprietary information disclosure.

37

Proprietary costs and information disclosure. As competitive intensity increases,

I expect managers assess a higher cost of disclosing information and are less likely to

reveal material inside information. Indeed, Graham, Harvey, and Rajgopal (2005) find

that concerns over competitors gaining a competitive edge from inside information is one

of the most significant factors influencing what information managers disclose. Using a

novel survey of over 400 managers, Graham et al. (2005: 62) document that ―nearly

three-fifths of survey respondents agree or strongly agree that giving away company

secrets is an important barrier to more voluntary disclosure.‖ In fact, these authors notice

that CFOs are highly aware of proprietary costs and ―do not want to reveal sensitive

proprietary information ‗on a platter‘ to competitors, even if such information could be

partially inferred by competitors from other sources…‖ (Graham et al., 2005: 64-65).

Connecting voluntary disclosure theory (Dye, 2001; Verrecchia, 2001) and the survey

conducted by Graham et al. (2005), I suggest managers are less likely to reveal inside

information when competitive intensity is higher than lower.

Justifications. The use of justifications in the SEO prospectus involves identifying

specific reasons or rationale for issuing the SEO prospectus. When managers provide

justifications, they allow outsiders the opportunity to know about both future strategic

initiatives that the firm plans to pursue and how much capital managers are dedicating to

those initiatives. Providing justifications both decreases information asymmetry and

increases the ability for outsiders to rationalize the strategic activities of the firm. Further,

outsiders may place more confidence in managers who appear to have specific strategies

defined when they issue an SEO. Autore et al. (2009) suggest that firms which issue

justifications in the SEO prospectus tend to perform better in the following years. To

38

provide justifications, managers might explain that the firm is going to use the capital to

pursue plant or retail expansion in new markets. They may also indicate that the firm is

going to consider acquisitions of other firms to bolster a specific technology.

In contrast, when competitive intensity is higher, managers issuing an SEO may

perceive a greater potential for their core rivals to respond competitively to justifications

provided in the prospectus (Chen & Miller, 2015; Kilduff et al., 2010). Perhaps they may

have concerns that their competitors may preempt them into new markets, or may

consider acquisition targets before the SEO-issuing firm does. Consequently, managers

may have trepidations about providing a roadmap of future strategic activity to competing

firms. Therefore, I expect managers are less likely to provide justifications for the SEO

issuance when they perceive greater levels of competitive intensity.

Hypothesis 1: Competitive intensity is negatively related to the number of

justifications in the SEO prospectus.

Information clarity. Information clarity involves managers disclosing information

in such a way that it is easier to read, consume, and process by outsiders. Less

information clarity involves opaque language, convoluted sentences, and unfamiliar

nomenclature, and more information clarity involves easy-to-read language, short

sentences, and typical business and financial nomenclature (Lehavy et al., 2011;

Loughran & McDonald, 2014). Although some scholars suggest the ability to present

information clearly is a skill managers possess (Kimble, 1994), other scholars suggest

managers may intentionally use opaque language and less clarity when they want to

dissuade outsiders from delving too deeply into the information (Dougal et al., 2012;

Easley & O'Hara, 2004). For example, managers may present less clear information to try

to conceal information from journalists (e.g., Dougal et al., 2012), analysts (e.g., Lehavy

39

et al., 2011), and investors (e.g., Lawrence, 2013). Ultimately, scholarship in this area

contends that managers vary in terms of the clarity of the information they disclose.

Connecting information clarity to competitive intensity, I suggest managers are

less likely to provide clear information when they perceive greater levels of competitive

intensity. Managers may intentionally use opaque and superfluous language in their SEO

prospectuses to dissuade their competitors from understanding the information contained

in the document. For example, managers could engage in less information clarity by

burying important information about the SEO issuance in long, wordy, and poorly-

written sentences. Conversely, managers could use more information clarity by

composing quick bullet points identifying important information. Managers‘ concerns

could also extend to competitors receiving analyzed information from security analysts

and business press. Consequently, managers may want to engage in less information

clarity so that analysts and press are less likely to cogently evaluate information in the

prospectus (Dougal et al., 2012; Lehavy et al., 2011; Loughran & McDonald, 2011) and

then disseminate that information to sources which competitors can access.

Hypothesis 2: Competitive intensity is negatively related to information clarity in

the SEO prospectus.

Casting a positive organizational image. Whereas the use of justifications or

information clarity provides greater insight into the inner workings of a firm, casting a

positive organizational image may not provide any new or material information about the

firm. As I addressed previously, scholars in this area suggest that managers attempting to

create a positive organizational image often focus on unrelated positive elements of the

organization (Benner & Ranganathan, 2012; Graffin et al., 2016) or the framing in which

information is presented (Cornelissen & Werner, 2014; Westphal & Zajac, 1998; Zajac &

40

Westphal, 1995). In either case, managers working to cast a positive organizational image

point to positive elements of their organization.

As it relates to competitive intensity and the corresponding proprietary costs of

voluntary disclosure, there are two related rationales that may suggest a positive

relationship between the competitive intensity and casting a positive organizational

image. First, proprietary costs relate only to disclosing material proprietary information

(Dye, 2001; Healy & Palepu, 2001; Verrecchia, 1990b, 2001). In the case of casting a

positive organizational image, managers do not disclose material information. Rather

they either highlight positive aspects of the firm or frame information in specific ways.

Thus, there are essentially no proprietary costs associated with casting a positive

organizational image. However, casting a positive organizational image adds length and

verbiage to the SEO prospectus. The literature and arguments about information clarity

suggest this comes at a cost. When proprietary costs are higher, managers may focus on

the benefits of projecting a positive image with less concern for the costs.

Second, scholars suggest that managers are likely to trumpet their

accomplishments and positive characteristics of their firms when competition is fiercer

(Eliashberg & Robertson, 1988; Porter, 1980; Rindova, Becerra, & Contardo, 2004). The

logic is that companies with more positive attributes can point to these characteristics in

hopes of dissuading competitors from entering their market, attacking, or responding to

an action (Eliashberg & Robertson, 1988). As Rindova et al. (2004) highlight, when a

firm perceives greater rivalry with specific competitors, managers are likely to use

language to signal that it has access to more resources and has better capabilities. The

41

authors suggest that managers do this because they hope to deter competitors from

entering product-markets and to rally support from key stakeholders.

Managers may a cast a positive organizational image in the SEO prospectus in a

number of ways. For example, managers may identify recent performance

accomplishments of the firm relative to its competitors, may highlight accolades received

by top managers (e.g., recognition in business press), or may actively use positive

language to describe the activities of the firm. In this study, I suggest the use of positive

language and tone relative to negative language and tone can represent casting a positive

organizational image. When competitive intensity is high, I expect managers want to look

favorable to outsiders and competitors.

H3: Competitive intensity is positively related to the appearance of positive

organizational images in the SEO prospectus.

Security Analyst Reactions – Consequences

In the previous section, I explored the antecedents of the use of information in the

SEO prospectus through the theoretical constructs of proprietary costs and competitive

intensity. I argued the competitive intensity represents an antecedent of information

disclosure and is connected to information releases via the mechanism of proprietary

costs. In this section, I turn my focus to the outcomes of the use of information in the

SEO prospectus. I argue are security analysts‘ reactions represent the outcomes of

information disclosure. Specifically, I suggest that analyst reactions are a benefit to

providing information in the SEO prospectus.

Security analysts and their reactions to information. Security analysts represent

one of the most important information intermediaries with whom managers can interact

(Benner & Ranganathan, 2012). Security analysts are individuals tasked with becoming

42

experts on a particular firm or sector in order to professionally evaluate the activities of a

firm and make recommendations to potential investors (i.e., analysts‘ clients) (Feldman,

Gilson, & Villalonga, 2013; Pfarrer et al., 2010). Firms tend to have relatively few

security analysts (approximately between 2 and 20) who distil information from the firms

and provide expert analysis for investors. In general, security analysts are in high demand

because investors often have neither the time nor the expertise to comprehensively

evaluate the performance prospects of a given firm or set of firms (Barber et al., 2001;

Feldman et al., 2013). As a result, security analysts are often able to sway the

perspectives of millions of investors based on their analysis of a firm, its activities, and

its ability to generate performance for its shareholders (Barber et al., 2001; Chung & Jo,

1996).

In general, security analysts complete two tasks for their clients. The first task

involves creating pro forma earnings projections, often referred to as earnings forecasts

(Feldman et al., 2013; Washburn & Bromiley, 2013). These forecasts help investors to

understand analysts expert perspectives on future earnings, which in turn help investors

make informed decisions (Barber et al., 2001). These earnings forecasts are fluid,

meaning that analysts may revise their forecasts as managers announce new strategic

initiatives (Abarbanell & Lehavy, 2003; Plumlee, 2003).

The second task analysts complete involves making recommendations of whether

or not they believe investors should buy a firm‘s stock or not (Barber et al., 2001; Benner

& Ranganathan, 2012; Luo et al., 2015). These stock recommendations come in the form

of discrete evaluations, such as ―strong buy‖, ―buy‖, ―hold‖, ―sell‖, or ―strong sell‖

(Wiersema & Zhang, 2011). When analysts make or revise a recommendation, millions

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of investors are left to interpret whether or not they want to follow the advice of the

experts (Barber et al., 2001; Fanelli, Misangyi, & Tosi, 2009). Research suggests,

however, that investors can earn better returns by following the recommendations of

security analysts (Barber et al., 2001; Fanelli et al., 2009; Jegadeesh & Kim, 2009). This

is particularly true during SEO issuances because analysts are thought to have more

sophisticated information about the firm and a greater ability to navigate information

asymmetry (Bowen, Chen, & Cheng, 2008; Dechow, Hutton, & Sloan, 2000).

Because analysts influence many investors, and owing to the partially subjective

nature of their evaluations, scholars have examined how managers might maintain

relationships with analysts (e.g., Pfarrer et al., 2010; Westphal & Clement, 2008;

Zuckerman, 1999). Scholars believe that analysts tend to respond more favorably to a

firm‘s announcements when its managers have a good relationship with analysts

(Washburn & Bromiley, 2013; Westphal & Clement, 2008). In fact, Westphal and

Clement (2008: 873) suggest maintaining a relationship with security analysts represents

a ―primary responsibility‖ for managers. Holding such a relationship with analysts may

help the firm in a variety of ways, including bringing more legitimacy to the firm

(Zuckerman, 1999) and influencing analysts to provide recommendations more consistent

with what managers believe (Barber et al., 2001; Chung & Jo, 1996).

A sizeable portion of the literature on managers‘ relationships with analysts

connects the information managers provide to the quality of the relationship (Pfarrer et

al., 2010; Washburn & Bromiley, 2013). Research suggests analysts prefer a greater

quantity of salient information about the inter-workings of the firm and its strategic

initiatives (Libby & Tan, 1999; Skinner & Sloan, 2002; Washburn & Bromiley, 2013).

44

For example, Washburn and Bromiley (2013: 852) describe how ―managers can

voluntarily issue predictions of their firm‘s future performance‖ in order to help analysts

with their task of projecting earnings. As another example, Pfarrer et al. (2010) describe

how managers can provide information to analysts in order to help decrease analysts‘

uncertainty about the firm and make more informed recommendations to investors. This

literature suggests that managers can benefit from being forthcoming with analysts.

There are two related reasons why open communication channels between

managers and analysts may benefit managers, both of which originated in the literature

on earnings management of earnings surprises.2 First, providing more information to

analysts can improve reactions because analysts‘ reputations are often damaged when

they are unable to predict strategic activities in advance of an announcement (Barron,

Byard, & Yu, 2008). In the context of SEOs, if managers do not provide information to

indicate for what they will use the capital raised, analysts may hold concerns that a future

strategic announcement using those funds may arrive unexpectedly, thus hurting their

reputation with their clients. Second, providing more information may benefit managers

because of analysts‘ individual biases that arise when they are under-informed

(Hirshleifer & Teoh, 2003; Houston, James, & Ryngaert, 2001). When analysts do not

have sufficient information about a firm or strategic activity, they often resort to

individual biases about surprising or new information. These biases are almost always

associated with negative reactions, especially when the information involves a potentially

2 Earnings surprise refers to an instance when the actual quarterly earnings of a firm are inconsistent with

the earnings forecasts analysts had previously projected (Libby & Tan, 1999; Pfarrer et al., 2010; Westphal

& Clement, 2008). In such instances, analysts tend to respond especially negatively, prompting managers

to often communicate information prior to an earnings announcement in order to avoid surprises (Libby &

Tan, 1999; Washburn & Bromiley, 2013).

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controversial activity like an SEO (Brown et al., 2015, 2016; Houston et al., 2001). In

fact, Westphal and Clement (2008) describe how managers may go to such lengths as

rendering favors for analysts in order to shift analysts to have more favorable perceptions

of (and thus biases toward) the firm.

Justifications. When issuing an SEO, managers may provide more information to

security analysts in order to avoid these negative outcomes. One way they may do so

involves the use of justifications in the SEO prospectus. Previously, I described the use of

justifications as providing reasons and rationale for issuing the SEO. When managers use

justifications, analysts are more informed about the ongoing activities of the firm. All

else equal, analysts then face less of a surprise when a firm announces a strategic activity,

and thus are less likely to have concerns over reputational damage or rely on their biases

when activities are announced.

I also postulate that providing justifications in the SEO prospectus may influence

analysts to respond more favorably to the SEO issuance on the basis of less perceived

controversy. I previously argued that SEOs represent controversial activities and that

capital market participants are often skeptical of the managers‘ motivations for issuing

the SEO (Cornett & Tehranian, 1994; DeAngelo et al., 2010; Loughran & Ritter, 1995). I

expect that using justifications will reduce the information asymmetry between managers

and capital market participants, thus eliciting fewer concerns over the motivations

underlying the SEO issuance. By providing justifications, managers can point to tangible

outcomes associated with the SEO issuance.

I contend justifications are beneficial both because they help avoid the negative

analyst reactions associated with future surprises and because they may limit the

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perceived controversy associated with the SEO issuance. Further, given that scholars

posit analysts substantially influence investors‘ trading behavior (Barber et al., 2001;

Feldman et al., 2013), I expect the benefits of providing more information via

justifications will distil to better stock market reactions. Given that I expect SEOs to

receive generally negative analyst responses, I am concerned primarily with how uses of

information in the prospectus influence analyst downgrades of their stock

recommendations for the firm following the SEO announcement. Analyst downgrades are

important outcomes because they tend to influence investors more than upgrades

(Westphal & Clement, 2008) and because analysts are apt to downgrade following a

controversial activity to maintain credibility with their clients (Brown et al., 2015).

Hypothesis 4: The number of justifications in the SEO prospectus is negatively

related to the number of analysts downgrading in the period following the SEO

issuance.

Information clarity. Scholars have suggested that the way in which information is

provided affects analysts‘ interpretation of and reactions to that information (Lehavy et

al., 2011). In a recent line of research in the finance and accounting literatures, scholars

suggest that information which is cumbersome, too complex, poorly written, or unclear is

often associated with negative reactions from capital market participants, including

security analysts (e.g., Bodnaruk, Loughran, & McDonald, 2015; Lehavy et al., 2011;

Loughran & McDonald, 2014). The general argument for this relationship is that ―lower

readability of firm financial disclosures increases the cost of processing the information

in these disclosures‖ (Lehavy et al., 2011: 1089). Put differently, financial documents that

are unclear make it more difficult for analysts and investors to consume, process, and

evaluate the information contained within them, thereby leading to negative reactions. In

47

an article about how firms may communicate the financial constraints they face,

Bodnaruk et al. (2015) suggest that opaque language or poorly written documents make it

harder for outsiders to find relevant information to include in their evaluations.

There are two related reasons why analysts might dislike information that is

communicated poorly or not in a clear fashion, both of which stem from the costs

associated with processing information (Hirshleifer & Teoh, 2003; Lehavy et al., 2011;

Plumlee, 2003). The first reason involves analysts‘ limited attention and that more

complex information requires more processing time. Hirshleifer and Teoh (2003) suggest

that analysts (like all humans) have limited attention, meaning that analysts ―attention

must be selective and requires effort (substitution of cognitive resources from other

tasks)‖ (2003: 341). This perspective is consistent with bounded rationality and

satisficing (Cyert & March, 1963; Kahneman, 2003; Scott & Davis, 2007). Second,

analysts have to spend more time gathering supplemental information when primary

information is difficult to understand or process (Aldrich & Fiol, 1994; Basdeo et al.,

2006; Rindova et al., 2006; Washburn & Bromiley, 2013). Taken together, processing

and evaluating unclear or vague information is associated with opportunity costs from

limited attention and gathering information. Analysts tend to dislike such opportunity

costs and therefore respond negatively to activities that increase these costs (Hirst,

Koonce, & Venkataraman, 2008; Plumlee, 2003; Washburn & Bromiley, 2013).

In a recent stream of research in the management literature, some scholars have

suggested that analysts‘ distaste for complex information or activities influences

information disclosure practices (Benner & Zenger, 2016; Litov et al., 2012). Benner and

Zenger (2016) even suggest that managers may go to extreme lengths to avoid potentially

48

confusing analysts, and may even choose less valuable but easy-to-evaluate strategies in

order to avoid adverse analyst reactions to complicated information. Similarly, Litov et

al. (2012) suggest analysts may choose to ignore value-creating information when that

information is complex and time-consuming to evaluate but that managers can improve

analyst reactions by decreasing the time it takes to evaluate the information provided.

I suggest that managers engaging in more information clarity can reduce the costs

associated with evaluating information and can improve analyst reactions to the SEO.

Much like the financial documents that extant work has analyzed (e.g., Bodnaruk et al.,

2015; Lehavy et al., 2011; Loughran & McDonald, 2014; Loughran & McDonald, 2015),

SEO prospectuses require written communication to explain the parameters of the equity

issuance itself, the landscape and competitive environment of the firm, and the potential

uses of the equity the firm is raising. As I suggested earlier, managers increase

information clarity when they compose this document in such a way that it is readable, it

uses conventional business nomenclature, and it does not use opaque language. In these

instances, I expect analysts to spend less time reading and processing the information in

the SEO prospectus. Additionally, if managers use opaque language or are generally

unclear, the analysts might not decipher the information. This leads to more uncertainty

about the information and negative analyst reactions (Zhang, 2006a). Thus, I anticipate

analysts to have lower opportunity costs from limited attention and gathering information

associated with analyzing the SEO.

Hypothesis 5: Information clarity in the SEO prospectus is negatively related to

the number of security analyst downgrading in the period following the SEO

issuance.

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Casting a positive organizational image. Recent scholarship in management has

examined how and when managers might present information to capital market

participants in order to improve their reactions to announcements of strategic activities

(e.g., Fiss & Zajac, 2006; Graffin et al., 2016; Pfarrer et al., 2010; Washburn & Bromiley,

2013). In fact, Washburn and Bromiley (2014) suggest that managers may strategically

use tactics specifically aimed at security analysts with the intention of persuading them to

react more favorably to a firm‘s announcements. Typically, security analysts are well-

informed individuals who deal in facts rather than anecdotes or images about an

organization (Zhang, 2006a). However, many scholars suggest that analysts are

susceptible to influence activities like all individuals. In their article, Washburn and

Bromiley (2013: 851) suggest ―analysts are sensitive to managerial influence practices‖,

such as projecting positive information to help analysts to make more favorable

decisions. Similarly, Fanelli and Misangyi (2006) suggest that analysts may produce

more favorable recommendations when they experience positive affect about the

organization. Taken together, I posit that analysts will respond more favorably to SEO

issuances that are accompanied by prospectuses that cast a positive organizational image.

There are three reasons why projecting a positive organizational image may

influence analysts (and other capital market participants) to respond more favorably to

the SEO issuance. First, creating a positive organizational image may help analysts to

weigh the potentially positive elements of the SEO stronger than the negative elements

(Mishina et al., 2010; Washburn & Bromiley, 2013). Analysts tend to put more emphasis

on negative information compared to positive information when making their analyses

(De Bondt & Thaler, 1990; Hong, Kubik, & Solomon, 2000). However, managers can

50

influence analysts to either discard negative information in favor of positive information

(Pfarrer et al., 2010) or perceive the information more positively (Mishina et al., 2010;

Washburn & Bromiley, 2013). For example, casting a positive organizational image may

work in the following way: Analysts could fixate on equity valuations of the SEO that

they perceive as potentially uncompromising or negative, but may instead focus on the

potential growth of the organization.

Second, casting a positive organizational image may help analysts deal with the

complex task of evaluating an SEO issuance (Washburn & Bromiley, 2013; Zhang,

2006a). Washburn and Bromiley (2013) suggest that because analysts‘ tasks require so

much complex cognitive processing, positive information (whether or not it is even

germane to the task at hand) may influence them to distil the information into more

favorable outcomes. In other words, analysts will seek cues about how to interpret

complex information such that they can infer the value of the activity (Rao, Greve, &

Davis, 2001). When managers can provide positive cues like casting a positive

organizational image, analysts tend to filter and process that information more favorably

for the organization (Rindova et al., 2006; Washburn & Bromiley, 2013).

Finally, analysts (and investors) have individual biases against activities that are

perceived as potentially controversial (Barberis, Shleifer, & Vishny, 1998; Bergman &

Roychowdhury, 2008; Hirshleifer & Teoh, 2003). Consistent with work about the

negative reactions when firms conduct potentially image-threatening activities (e.g.,

Elsbach, 2014; Elsbach, Sutton, & Principe, 1998; Gao et al., 2016), casting a positive

organizational image may help dissuade analysts‘ biases or negative sentiment against the

controversial nature of an SEO issuance. In other words, when managers cast a positive

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organizational image, analysts may interpret the otherwise controversial signals (e.g.,

capitalizing on overvaluation) associated with the SEO more favorably (Mishina, Block,

& Mannor, 2012; Washburn & Bromiley, 2013).

This is not to suggest that analysts are incapable of objectively evaluating the

merits of an SEO and responding accordingly. Instead, I suggest that analysts, by the

nature of their jobs, are likely to respond negatively to SEO issuances because of the

complexities associated with the SEO and the controversial nature of the activity. Since

they are still tasked with evaluating it, however, I predict managers can induce more

positive affect by casting positive organizational images, thus improving analyst

reactions (or decreasing negative reactions) to the SEO issuance.

Hypothesis 6: The appearance of positive organizational images in the SEO

prospectus is negatively related to the number of security analysts downgrading in

the period following the SEO issuance.

Moderating effects of information clarity. I also expect the use information clarity

will compound the benefits associated with the use of justifications in the SEO

prospectus. In other words, I expect that using justifications in the absence of

information clarity may not provide many benefits to security analysts. Because

justifications provide more information, they may actually contribute to more perceived

information asymmetry when the information provided is not clear (Jiang, Lee, & Zhang,

2005; Zhang, 2006a, 2006b). Stated differently, I suggest simply providing more

information is often unhelpful unless that information is easy to process.

Providing justifications without doing so clearly is tantamount to decreasing the

signal-to-noise ratio of the information, which is sometimes associated with outcomes

such as information overload (Agnew & Szykman, 2005; O'Reilly, 1980) and increased

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cognitive processing demands (Hirshleifer & Teoh, 2003; Paas, Van Gog, & Sweller,

2010; Tversky & Kahneman, 1985). Scholars from a variety of disciplines spanning

management (e.g., O'Reilly, 1980), economics (e.g., Kahneman & Tversky, 1979),

accounting (e.g., Plumlee, 2003), finance (e.g., Zhang, 2006a), and psychology (e.g.,

Bargh & Thein, 1985) suggest that this type of information overload negatively impacts

decision-makers (in this case security analysts).

However, managers who can couple justifications with information clarity may

receive even more benefits from providing those justifications. This is to say that using

justifications may elicit even more favorable responses from security analysts when the

SEO prospectus is easier to read. In this circumstance, analysts are not only able to better

rationalize and make sense of the SEO issuance, but are also able to do so in a way that

minimizes the cognitive taxation associated with evaluating the information; this, in turn,

simultaneously decreases perceived information asymmetry, the costs associated with

limited attention, and the costs associated with gathering information.

Hypothesis 7: Information clarity in the SEO prospectus moderates the

relationship between justifications and security analyst downgrades; the

relationship is more negative when information clarity is high and less negative

when information clarity is low.

I also expect the benefits from casting positive organizational images change as

information clarity varies. Although it may appear as though creating positive

organizational images in the SEO prospectus is costless, doing so comes at the expense of

added length that may not perceive the information as pertinent to the SEO. For example,

framing information positively may require more text in order to explain the framing

(e.g., Fiss & Zajac, 2006), and using positive language to manage impressions may

involve more text to accommodate positive language (e.g., Graffin et al., 2016).

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Regardless of how casting a positive organizational occurs, it comes at the expense of

added length to the SEO prospectus.

In the above sections I outlined the reasons why analysts dislike more, as opposed

to less, text in financial documents (Lehavy et al., 2011; Zhang, 2006a). Analysts may

especially dislike such information when it does not directly pertain to data they can use

to value the firm and evaluate its financial performance. Some scholars have even

suggested that capital market participants disapprove of any information that is not

perceived as pertinent to their evaluations (Giorgi & Weber, 2015). I expect this distaste

is exacerbated when information is not easily read and processed. Consequently, I predict

that managers will benefit from coupling positive organizational images in the SEO

prospectus with information clarity. When managers can make the SEO prospectus

clearer, positive organizational images will not only resonate more with readers but will

also decrease the potential for analysts to react negatively from information overload.

Hypothesis 8: Information clarity in the SEO prospectus moderates the

relationship between positive organizational images and security analyst

downgrades; the relationship is more negative when information clarity is high

and less negative when information clarity is low.

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CHAPTER 4

METHODOLOGY AND EMPIRICAL ESTIMATION

Sample

The sample for this study is all SEO issuances in the years 2000-2015. I selected

this time period because it spans several global and domestic macroeconomic cycles

(www.bls.gov) and because it follows an IPO boom in the previous decade, such that

SEOs became more conventional in the years following (Certo et al., 2009; DeAngelo et

al., 2010; Loughran & Ritter, 1995). I gathered the SEO issuance from the Thomson

Reuters SDC Platinum ―New Issues‖ database. This database contains all of the SEO

issuances and some descriptive information about the offering and the firm. I retained

only those SEO issuances that actually occurred (i.e., removed announcements that

dissolved) from firms with headquarters in the United States. This initial search yielded

33,415 total SEOs, many of which did not meet the data screening criteria I describe next.

Following research on SEOs (e.g., Gao & Ritter, 2010; Henry & Koski, 2010) and

consistent with my description of the type of issuance in which I am interested in this

study, I retained only those conventional SEO issuances wherein the firm issued equity to

shareholders in exchange for capital. In other words, I removed SEO issuances that

reflect large exchanges of shares on the secondary market or the conversion of share type,

which are referred to as SEOs for regulatory reasons but are not of interest for this study

(Kalay & Shimrat, 1987).

I also removed SEO issuances of firms in industries that do not compete in the

traditional sense (e.g., financial intermediaries, public utilities, government services,

social services) (e.g., Arrfelt et al., 2015; Misangyi et al., 2006). A complete list of

55

industries removed from the sample is included in Table 4. Removing these industries

was important because one of my primary independent variables reflects firms‘

competition (i.e., competitive intensity). Such highly regulated industries may distort how

managers perceive competition, and thus they may contaminate my sample (Chen &

Miller, 2012; Park & Mezias, 2005). Further, I retained only those SEO issuances from

firms listed in S&P 1500 index and that had at least two security analysts tasked with

monitoring the firms in the SEO-issuing year. This is important because my final

dependent variable represents security analyst reactions, therefore firms with fewer than

two analysts will not feature any variance on the dependent variable.

Finally, I retained only those SEO issuances with dates I could manually verify

with the actual SEO prospectus. I located the prospectuses on the Securities and

Exchange Commission‘s (SEC) EDGAR website. Because of some of the legal nuances

associated with SEO issuance dates, announcement dates, and effective dates, the date

SDC Platinum lists does not always align with the date the SEC has on file. A

representative of Thomson Reuters suggested this occurred due to errors from its internal

employees tasked with coding the SEO issuances. Appropriately, I used the dates listed

from the SEC, and I removed observations with dates I could not verify.

Because of these data cleaning procedures, I wanted to ensure my final sample is

representative of the broader population of SEO issuers. I employed a Kolmogorov-

Smirnov (K-S) test to ensure my final sample is similar to original pull of all the SEOs.

To do so, I used several firm- and SEO-level characteristics such as size, issuance

amount, growth, and performance (Gibbons & Chakraborti, 2011; Smirnov, 1939;

StataCorp, 2015). After performing these procedures, I had 1,324 SEO issuances. After

56

accounting for missing data from SDC, the SEC, and the other databases I used (e.g.,

Compustat, CRSP, IBES), my final sample was 842 usable SEO issuances.

Testing the Antecedents of the Uses of Information

Figure 1 depicts the theoretical framework in this study. Given that the model

includes both antecedents and outcomes of the uses of information, there are two

different sets of empirical analyses to test my hypotheses. Competitive intensity

represents the antecedent of uses of information in the SEO prospectus and is featured on

the left side of the figure. This section corresponds to the portion of the figure denoted as

―Empirical Model 1.‖

Dependent variables. Justifications was measured as the number of uses of funds

listed in the ―Uses of Proceeds‖ section of the SEO prospectus (e.g., Autore et al., 2009).

Thus, justifications represents a count of the number of uses of the proceeds that the firm

lists in the section. I created this count using the ―uses of proceeds‖ variable from the

SDC Platinum database, which lists one to nine reasons why the firm issued the SEO.

Since my variable justifications is intended to capture reasons or rationale for the

issuance (Gao et al., 2016; Porac et al., 1999; Rhee & Fiss, 2014), I did not include

uninformative reasons. Because every firm in the sample lists ―general corporate

purposes‖ as a potential use of the proceeds, my variable does not include this as a

descriptive justification. Firms that listed only ―general corporate purposes‖ received a

value of 0 for the justifications variable, which occurred 231 times.

SDC platinum categorizes eight broad categories of justifications which firms

tend to use in their SEO prospectuses. To ensure their accuracy, I independently coded

the uses of proceeds and arrived at the same at broad categories. These categories include

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financing future acquisitions, paying down debt, funding a stock repurchase program,

financing capital expenditures, capitalizing fees and expenses, financing the purchase of

marketable securities, capitalizing external loans, and improving working capital. For the

purposes of this study, I assume each of these justifications is equally informative. Thus,

I consider each justification added as representing more information provided. I do not

detect any significant differences in market reactions to different justifications listed,

therefore I believe my assumption is reasonable.3

Information clarity involves presenting information in the SEO prospectus in such

a way that outsiders can read and process it quickly. I measured information clarity as the

number of words per sentence in the SEO prospectus. Research in finance and accounting

has examined an exhaustive list of variables that could represent information clarity (or

readability) as a construct for financial documents (Bodnaruk et al., 2015; Lehavy et al.,

2011; Loughran & McDonald, 2014, 2015). These scholars looked at variables such as

the number of words per sentence, the file size of document, the number of words in a

document, the number of complex words in the document, a score for the cognitive

processing language, and the percentage of business-relevant nomenclature (Lehavy et

al., 2011; Loughran & McDonald, 2011, 2014, 2015).

Overwhelmingly, the literature suggests that the number words per sentence in the

document exhibits a number of advantages as a measure for information clarity (Lehavy

et al., 2011; Li, 2008; Loughran & McDonald, 2014). Lehavy et al. (2011) describe how

former SEC chairman Christopher Cox uses this measure to examine information

complexity. He stated, ―Just as the Black-Scholes model is commonplace when it comes

3 As a robustness check, I standardized all of my information variables by industry. The results are

substantively similar to those reported.

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to compliance with the stock option compensation rules, we may soon look to [words per

sentence-based] models to judge the level of compliance with the plain English rules‖

(Cox, 2007). This is consistent with research in psychological and communications that

also suggests words per sentence represents an appropriate measure for how clearly

information is communicated (Flesch, 1948; Hunt, 1983; Kimble, 1994). These scholars

suggest that short sentences result in clear and effective writing, which aligns with the

―plain English‖ SEC mandates that Cox (2007) references.

Casting a positive organizational image involves speaking positively about, or

framing information around, favorable aspects of the organization. To measure this, I

used a dictionary that captures the use of positive and negative language in a document.

This dictionary was created by the software developers of Linguistic Inquiry and Word

Count (LIWC), which is a computer-aided text analysis software package (Pennebaker,

Booth, & Francis, 2007; Pennebaker & Francis, 1996). These dictionaries have been

validated in a variety of contexts and are frequently used to represent the degree to which

the author of a document takes a positive tone or perspective (Bednar, 2012; Pfarrer et al.,

2010; Zavyalova et al., 2012).

Following recent work in the management literature, my measure is the score for

positive language minus the score for negative language (e.g., Bednar et al., 2014;

Bednar, Boivie, & Prince, 2013; Zavyalova et al., 2012). Scholars indicate they prefer

this measure over other types of positive sentiment measures because of its validity and

interpretability (Bednar et al., 2013; Zavyalova et al., 2012).4

4 As robustness checks, I also measured this variable as the total score for positive language while simply

controlling for negative language and as a ratio of positive-to-negative language. The results were

substantively similarly.

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Independent variable. Competitive intensity was measured using the number of

competitive actions in an industry for a given year (Chen & Miller, 2012; Nadkarni,

Chen, & Chen, 2015; Smith, Ferrier, & Grimm, 2001). Following research in the area, I

examined the number of product- or service-related activities reported in the media for

each firm in all of the industries (by the three-digit SIC code) represented by firms in the

S&P 1500 (Andrevski, Brass, & Ferrier, 2016; Nadkarni et al., 2015; Rindova, Ferrier, &

Wiltbank, 2010). I used the Ravenpack database to identify the product- or service-

related actions by all firms comprising these industries. Ravenpack is a database that

aggregates news and press releases about firms, and it collates the news into several

different categories. For example, a news story or press release could be about earnings,

revenue, trading, labor, acquisition, products/services, orders, and many other topics. For

the purposes of this study, I was interested in the products/services category, as this

represents externally directed competitive actions (Andrevski et al., 2016; Ferrier, Smith,

& Grimm, 1999; Rindova et al., 2010). The product- or service-related activities include

competitive actions such as receiving a new contractual agreement for a product/service,

launching a new product/service, discontinuing a product/service, increase or decreasing

the price of a product/service, and applying/withdrawing regulatory approval for a

product/service. To create my measure, I divided the number of competitive actions per

3-digit SIC code by the total number of firms in the industry.5

Empirical estimation. I employed seemingly unrelated regression to examine the

effects of competitive intensity on each of the three different uses of information

variables. Seemingly unrelated regression is appropriate when the hypothesized and

5 Following Nadkarni et al. (2015), as a robustness check, I divided the number of competitive action in an

industry by the Herfindahl-Hirschman Index (HHI) for that industry. The results are substantively similar.

60

control independent variables are the same between models with a different dependent

variable, such as is the case with my data (Cameron & Trivedi, 2010; Reuer et al., 2013).

Seemingly unrelated regression uses feasible generalized least-squares regression in one

simultaneous model to estimate coefficients when multiple dependent variables may

share contemporaneous error (Cameron & Trivedi, 2010; Greene, 2011; Zellner, 1962).

The test to determine if the errors between the multiple models are independent is

referred to as the Breusch-Pagan Chi2 measure (Krause & Semadeni, 2013; Reuer et al.,

2013; Zellner, 1962). The Breusch-Pagan Chi2 for my data rejected the null that my

models were independent (2=104.4; p=0.000), which suggested seemingly unrelated

regression represents an appropriate model.

I employed two robustness checks in addition to the seemingly unrelated

regression. First, I employed three different models to examine the effects of competitive

intensity on each of the three different uses of information variables. To test the

relationship between competitive intensity and justifications, I employed a zero-inflated

negative binomial model. A zero-inflated negative binomial model is appropriate because

there are several observations with the value zero (Long, 1997; Vuong, 1989) and the

data are over-dispersed (Greene, 2011; Kennedy, 2008). I employed linear regression in

the second stage in the models featuring casting a positive organizational image and

words per sentence because these variables are continuous (Baum, 2006; Kennedy,

2008). In all three cases, I employed robust standard errors that were clustered by the

firm because same firms appeared more than once in the sample (Baum, 2006). These

results were substantively similar to those of the seemingly unrelated estimator.

However, I retained the seemingly unrelated estimator because of the dependence

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between the three models and because it allowed me to compare coefficients between the

three dependent variables.

Second, I employed Heckman two-stage models because I was concerned about

the potential for an unmeasured variable to influence both the decision to issue an SEO

and the uses of information in the SEO prospectus, thus creating sample selection bias

(Heckman, 1990; Kennedy, 2008). The Heckman model featured two stages. In the first

stage, the model predicted the probability of a firm issuing an SEO. The population for

my Heckman model was all firms in the S&P 1500 with at least two security analysts in

any given year for the years in my sample. Thus, the sample for the Heckman model

included 12,708 observations not associated with an SEO and 842 firms that issued an

SEO. The second stages of the models predicted the dependent variables of interest using

the same estimating techniques described above and included an adjustment factor

(referred to as a hazard lambda) computed from the first stage estimation (Baum, 2006;

Certo et al., 2016; Wooldridge, 2010).

Research on Heckman models suggests a Heckman estimator is appropriate when

the independent variable from the first stage is a significant predictor in the first stage,

there are at least two exclusion restrictions (which are the analog of instruments in other

two stage models), and the inverse Mills ratio is a significant predictor in the second

stage (Certo et al., 2016; Sartori, 2003; Wooldridge, 2010). In my model, competitive

intensity does not significantly predict inclusion in the sample and the inverse Mills ratios

are not significant in the second stage, despite the fact I have two strong exclusion

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restrictions.6 Therefore, a Heckman model is inappropriate and I proceeded using the

seemingly unrelated regression.

Testing the Consequences of the Uses of Information

In the above section, I described the empirical models corresponding to the

antecedents of the uses of information. In this section, I turn to the outcomes of the uses

of information. This is depicted on the right side of Figure 1 and is accompanied by the

header ―Empirical Model 2.‖ As I describe below, all of the independent variables here

were derived from the SEO prospectuses. Thus, there was no possibility for sample

selection bias, since sample selection bias can only occur when the independent variable

appears in a broader population of the sample used in the study (Certo et al., 2016;

Wooldridge, 2010). Accordingly, the sample for testing the consequences of the uses of

information is the 842 observations from the second stages in the previous models.

Dependent variables. Security analyst downgrades represents the number of

security analysts who downgraded their stock market recommendation of the firm in the

monthly period following the SEO issuance.7 I gathered these data from the ―Detail‖

section of the Institutional Brokers‘ Estimate Database (I/B/E/S). Analyst downgrades are

an important outcome because they are frequently associated with decreased equity

valuations, a strong effect of trading behavior, and less access to capital markets (Frankel,

Kothari, & Weber, 2006; Westphal & Clement, 2008).

6 My exclusion restrictions were the number of SEOs in the industry within the previous three years and the

debt-to-current assets of the ratio of the firm. Both of these significantly predicted inclusion in the sample

but not any of the information-related variables from the SEO prospectuses. 7 As a robustness check, I measured this variable also as the ratio of downgrades to total security analysts.

While the coefficients were different, the significance tests were nearly identical. I retained a count of the

downgrades because it is perhaps more straightforward to interpret than a proportion.

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Following Westphal and Clement (2008), I measured downgrades instead of

analyst upgrades for two reasons. First, research on SEOs suggests analysts tend to

respond negatively to an SEO issuance, and thus analyst downgrades are a more

appropriate outcome. In other words, I suggest managers work to prevent analysts from

downgrading their recommendation of the firm. Second, analyst downgrades tend to have

a more significant effect on investor trading than do analyst upgrades (Frankel et al.,

2006; Womack, 1996).

Independent variables. The independent variables relating to the outcomes of

information in the SEO prospectus are represented by the dependent variables from the

previous section (i.e., the antecedents of information). The measures for justifications,

casting a positive organizational image, and information clarity remained the same in

these models as they did for the models describe above.

Empirical estimation. I employed two-stage zero-inflated negative binomial

models (2SZINB) to examine the relationships between the uses of information in the

SEO prospectus and the extent to which analysts downgrade their recommendation of the

firm following the SEO issuance. I did so because I am concerned about the possibility of

unmeasured factors that might influence both the uses of information in the SEO

prospectus and the capital market outcomes. As a result, conventional single-stage

estimators might produce parameter estimates that are biased from endogeneity (Bascle,

2008; Semadeni, Withers, & Certo, 2014). Much like the Heckman models described

above, 2SZINB models consist of two stages; the first stage predicts the independent

variable (i.e., uses of information) and the second stage predicts the dependent variable of

interest (i.e., capital market outcomes) (Hamilton & Nickerson, 2003; Kennedy, 2008;

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Semadeni et al., 2014). I employed robust standard errors clustered by firm in both stages

of the models.

The first stage in the 2SZINB model must feature instruments, which are

variables that are significantly related to the uses of information in the SEO prospectus

but are not related to analyst downgrades (i.e., uncorrelated with the error term in the

second stage regression) (Baum, 2006; Semadeni et al., 2014). Following the

recommendations of scholarship in the area, I used two instruments (Hamilton &

Nickerson, 2003; Semadeni et al., 2014). Total character length represents the total

number of characters in the SEO prospectus. As managers use more characters in the

SEO prospectus, there is a greater likelihood for justifications and casting a positive

organizational image, while there is a lower likelihood for information clarity (i.e., there

are likely more words per sentence). HHI is the Herfindahl index for the 3-digit SIC code

in which the firm competes. Some scholars also suggest that competitive intensity is

represented by the density of firms in an industry (Kotha & Nair, 1995; Li, Poppo, &

Zhou, 2008; Ramaswamy, 2001; Su, Dhanorkar, & Linderman, 2015). As Li et al. (2008:

391) suggest, HHI is ―a popular indicator of the competitive intensity that captures the

number and market share distribution of firms in an industry.‖ The HHI significantly

relates to all of the uses of information for all the reasons hypothesized since it is similar

to competitive intensity, but it is correlated with competitive intensity at only 0.15 and it

does not appear to affect analyst recommendations of a specific firm. These relationships

are displayed in the ―Instruments‖ section of Table 3.

As a robustness check, I also examined the relationship between the three uses of

information and security analyst downgrades using structural equation modeling (SEM).

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As Shook et al. (2004: 397) describe, ―SEM has a unique ability to simultaneously

examine of series of dependence relationships, while also simultaneously analyzing

multiple dependent variables.‖ As it relates to my study, SEM allowed me simultaneously

include all of my independent variables and their instruments in the same model instead

of in separate two-stage models or a system of equations model (Bollen, 2014; Chadwick,

Super, & Kwon, 2014; Shook et al., 2004). Since my dependent variable required a

negative binomial estimator, I employed generalized SEM (GSEM), which is the only

method to incorporate non-linear modeling into SEM estimation (Anderson & Gerbing,

1988; StataCorp, 2015).

The results from a GSEM were similar to those from the 2SZINB model I

describe, except the parameter estimate for positive organizational image cannot be

differentiated from zero. Three fit statistics suggest SEM is not an appropriate model for

my analyses. First, the CFI was 0.286, whereas an appropriate minimum is approximately

0.90. Second, the RMSEA was 0.107, whereas an appropriate maximum is approximately

0.05/ Third, the Tucker-Lewis index was 0.05, whereas values should approach 1 (Kline,

2015; StataCorp, 2015; Williams, Vandenberg, & Edwards, 2009). These poor fit

statistics likely occurred because SEM is typically appropriate when there are latent

variables, of which my model has none (Kline, 2015; Shook et al., 2004). Accordingly, I

reserved these SEM analyses as a robustness check only.

Control Variables (Both Models)

The control variables described in this section were employed in each of the

models corresponding to both the antecedents and consequences of the uses of

information. Some of the control variables are specific to the SEO issuances. Thus, these

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controls were employed only in the second stage of the Heckman models. Accordingly, I

denote such variables in Table 2 under the ―Second Stage Only Controls‖ section. All of

the control variables are lagged one fiscal year unless they relate specifically to the SEO

issuance or are otherwise denoted.

Given that SEOs represent a stock market-based activity, I measured several

market-based controls. Stock return volatility represents the standard deviation of

monthly stock returns in the 12 months preceding the SEO issuance. Higher stock return

volatility suggests higher expected returns for investors and may change the perceptions

of how analysts view SEO issuances and how managers use language in the prospectus

(French, Schwert, & Stambaugh, 1987; Khan, 2010). Market capitalization reflects a

firm‘s stock price multiplied by its outstanding shares. In other words, it is a market-

based measure for firm size. Scholars suggest that firms across different sizes behave

differently in several ways, some of which include information disclosure and outsiders‘

evaluations of the firm (Healy & Palepu, 2001; Josefy et al., 2015; Lu, Chen, & Liao,

2010).8 Stock returns captures the industry-year adjusted stock market returns in the 12

months preceding the SEO issuance. This variable determines a firm‘s momentum and

how successful it has been in the time leading up to the SEO issuance. Managers of more

successful firms may interpret more discretion about what they can and should disclose,

and analysts may perceive these firms differently than unsuccessful firms (Bamber &

Cheon, 1998; Krishnan et al., 2010). Market-to-book ratio is the market value of the

firm‘s equity divided by the book value of the firm‘s equity (Cho & Pucik, 2005). This

variable represents the growth the market expects for a firm (Crossland & Hambrick,

8 Market capitalization, cash and equivalents, and issue size were all logged to account for skewness in the

data (Quigley & Hambrick, 2014).

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2011; Quigley & Hambrick, 2014). Higher growth firms issuing SEOs may expect more

favorable analyst reactions (Krishnan et al., 2010).

I also controlled for characteristics of the firm unrelated to the stock market. Cash

and equivalents represents the liquid assets the firm has on its balance sheet. Firms with

more liquid assets may have different reasons for issuing equity in exchange for capital,

and firms with less liquid assets may need the capital more so than those with liquid

assets, and such issuances may be met with more suspicion from analysts (Autore et al.,

2009; DeAngelo et al., 2010). Industry dynamism represents the variance in the sales

growth of an industry over the previous five years (Arrfelt, Wiseman, & Hult, 2013; Dess

& Beard, 1984). Industries with higher dynamism are more unstable, and managers

competing in those industries may have to make more judicious decisions (Arrfelt et al.,

2013; Crossland et al., 2014; March & Simon, 1958). Duality takes the value of 1 if the

firm has a CEO who is also the chairman of the board of directors and 0 if not. CEOs

with duality may experience different levels of discretion than CEOs without duality

(Busenbark et al., 2016; Krause, Semadeni, & Cannella, 2014). Litigation represents the

total number of lawsuits in which the firm is engaged in the SEO-issuing year. Scholars

suggest the extent to which a firm is involved is engaged in litigation will shape how it

discloses information (Lin, Officer, & Zou, 2011; Thompson & Thomas, 2004).

Since the dependent variable to test to the consequences of the uses of

information involves security analysts, I controlled for several variables related to

security analysts. All of the analyst-related controls were measured in the fiscal year of

the SEO issuance. Mean analyst recommendation reflects the average recommendation

across all of a firm‘s analysts in a given time period. Analyst recommendations take

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values between 1 and 5, where 1 represents ―strong buy‖ and 5 represents ―strong sell.‖

This variable captures analysts‘ general evaluations of a firm‘s performance prospects

(Wiersema & Zhang, 2011; Zhang, 2006a). Analyst recommendation dispersion captures

the standard deviation (or dispersion) of the numerical values associated with analysts‘

recommendations of a firm. Higher values depict less analyst consensus about the firm‘s

prospects. Scholars suggest that when recommendation dispersion is higher, analysts are

more uncertain about the activities of a firm and may benefit more from additional

information than when recommendation dispersion is low (Baginski et al., 1993; Barron

& Stuerke, 1998). Total number of analysts following reflects the total number of

analysts who issued recommendations about a firm in the given time period. I also

controlled for whether or not firms had high reputation analysts covering the firm in the

SEO-issuing year. High reputation analysts may both monitor the firm more closely and

may influence other analysts to react. Following research in the area, I code whether or

not a firm had an analyst covering it who was named to Institutional Investor Magazine‘s

All-Star analyst list (e.g., Boivie, Graffin, & Gentry, 2016; Ertimur, Mayew, & Stubben,

2011; Stickel, 1992).

I also controlled for several characteristics of the SEO issuance itself. Shelf

issuance dummy took the value of 1 if the SEO issuance is associated with a shelf

offering and 0 if not. Shelf offering refers to SEC Rule 415, and it occurs when an SEO is

placed on a proverbial ―shelf,‖ whereby investors can contribute capital at multiple

occasions over the life of the issuance (Henry & Koski, 2010). Although I removed all

subsequent issuances associated with a shelf offering, this dummy denotes if the first

issuance may be associated with future issuances. More than 1 SEO issuance dummy

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represents instances when a firm issued more than 1 SEO in a fiscal year (not as a part of

a shelf offering). To eliminate problems with nonspherical disturbances (e.g., Kennedy,

2008), to ensure my observations are independent, and to maintain variance in the

independent variables across each observation, I removed any SEO issuance that

occurred after the first issuance in a fiscal year. In such cases, I assigned this dummy

variable to account for potentially unique characteristics associated with these firms that I

could not measure. Size of the issuance measures the amount of capital the firm received

in exchange for equity in the SEO issuance. Larger issuances are higher profile and have

potentially greater implications for shareholder value and analyst perceptions than

smaller issuances (Bowen et al., 2008). This variable was logged.

I also controlled for reactive language in the SEO prospectus. The order in which

competitive moves occur may influence how managers disclose information. For

example, a firm first announcing a strategy may not disclose as much information in

order to prevent competitors from copying the activity as would a firm reacting to a

strategic move by a competitor (Chen & Miller, 2012; Smith et al., 2001). Since my

measure for competitive intensity captures the competitive actions of the firms in an

industry, this control variable attempts to capture whether or not managers appeared to be

focused on past actions (i.e., reactive competition) or future actions (i.e., preemptive

competition).

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CHAPTER 5

RESULTS

Table 1 displays the correlations and descriptive statistics for the variables in this

study. The correlations between covariates appear sufficiently low enough to not

introduce problems from multicollinearity. Among the highest correlations between non-

hypothesized covariates are some of the size-related variables, such as the total number of

analysts following the firm and the market capitalization of the firm, as well as the degree

to which a firm was involved in litigation. To ensure these variables did not contaminate

the empirical modeling, I employed Stata‘s -nestreg- command. This command shows

the parameter estimates with and without specified controls. This procedure did not

produce any substantively different results than the final results included in this study.

The remaining correlations between variables are consistent with small or moderate

effect sizes (Cohen, 1992; Cohen et al., 2003), which I do not expect to introduce

problems in the analyses. In addition, the correlations between the instruments and/or

exclusions restrictions and the variables of interest are sufficiently high enough to imply

they are strong instruments (Certo et al., 2016).

Table 2 displays the results corresponding to Hypotheses 1-3, which represent the

antecedent of the uses of language in the SEO prospectus. I used seemingly unrelated

regression to test these hypotheses. In Hypothesis 1, I predicted a negative relationship

between competitive intensity and the number of justifications a firm provides in the SEO

prospectus. Table 1 column ―Justifications‖ provides support for this hypothesis (=-

0.095; p=0.022). In Hypothesis 2, I argued that there is a negative relationship between

competitive intensity and information clarity. Column ―Information Clarity‖ in Table 2

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provides support for this hypothesis (=-0.234; p=0.040). As I describe above, I inverted

words per sentence such that the measure and construct are in the same direction. Thus,

this parameter estimate suggests that managers use more words per sentence (i.e., are less

clear) as competitive intensity increases. Finally, in Hypothesis 3 I posited a positive

relationship between competitive intensity and casting a positive organizational image in

the SEO prospectus. The column ―Positive Organizational Image‖ in Table 2

demonstrates support for this hypothesis (=0.048; p=0.012).

Amongst the several advantages seemingly unrelated regression provides that I

describe above, it also computes an R-squared value that compares the relative variance

explained between the models and a baseline prediction (Greene, 2011; StataCorp, 2015).

Table 2 contains the R-squared values associated with each of the models. As displayed

in Table 2, the R-squared value associated with information clarity (R2=0.520) is

drastically higher than it is for justifications (R2=0.266) or for positive organizational

image (R2=0.172). Interestingly, the incremental R

2 for each part of the model from

adding competitive intensity is approximately identical (R2 is approximately 0.06).

Table 3 displays the results corresponding to Hypotheses 4-8. I used a two-stage

zero-inflated negative binomial model to test these hypotheses. The first stage of the two-

stage model predicts the independent variable of interest from the second stage of the

model. I used all of the control variables as well as the two instruments listed in Table 3

in the first stage prediction. For the sake of parsimony, the only first stage estimates

displayed in Table 3 correspond to the two instrumental variables. Table 3 displays the

parameter estimates for competitive intensity and total words in the prospectus on the

sub-header ―Instruments.‖

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For each Hypothesis 4-8, I predicted a negative relationship between the uses of

information in the SEO prospectus and security analyst downgrades following the SEO

issuance. In Hypothesis 4, I predicted a negative relationship between the number of

justifications provided in the SEO prospectus and analyst downgrades. The column

―Justifications‖ in Table 3 provides support for this hypothesis (=-0.811; p=0.002). This

coefficient translates into approximately one fewer analyst downgrade for every two

justifications provided, or it translates to approximately 2.5 times fewer analysts

downgrading on average for each justification.

In Hypothesis 5, I posited a negative relationship between information clarity and

security analyst downgrades. The column ―Information Clarity‖ in Table 3 depicts the

opposite actually occurs in my sample (=0.293; p=0.047). Put differently, this suggests

that analysts actually respond better when managers use more words per sentence.

Finally, in Hypothesis 6 I predicted a negative relationship between casting a positive

organizational image and analyst downgrades. The column ―Positive Organizational

Image‖ in Table 3 provides moderate support for this hypothesis (=-3.069; p=0.045).

Using one standard deviation more positive language in a prospectus than average results

in approximately two times fewer analyst downgrades than average.

In Hypotheses 7-8, I predicted that information clarity moderates the relationship

between both justifications and positive organizational image with analyst downgrades. I

suspected that information clarity will strengthen these relationships, such that fewer

analysts will downgrade when information is clearer. The column ―Interactions‖ in Table

3 shows the estimates corresponding to these hypotheses. I find support for Hypothesis 7,

which posited that the negative relationship between justifications and analysts

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downgrades will become even more negative when information clarity is high (=-0.076;

p=0.033). I do not find support for Hypothesis 8, which predicted the negative

relationship between positive organizational image and analyst downgrades will become

even more negative when information clarity is high (=-1.392; p=0.153).9

9 It is important to note that I tested these interactions in separate models. A fully specified model with all

of the interactions could not converge because of an identification issue associated with using the same two

instruments for each of the variables.

74

CHAPTER 6

DISCUSSION

In this study, I suggest managers possess valuable proprietary information about

their firms which they can voluntarily disclose. I expect that outsiders want this

proprietary information, but such disclosures may both help and/or harm the disclosing

organization. On one hand, managers can provide information to security analysts to

reduce information asymmetries and improve capital market perceptions of their firms

(Gao & Ritter, 2010; Healy & Palepu, 2001; Washburn & Bromiley, 2014). On the other

hand, competitors can use that same information to give their own firms a competitive

edge (Chen & Miller, 2012; Lang & Sul, 2014; Verrecchia, 2001). This presents a

problem for managers: They want to provide information to help improve capital market

reactions but are hesitant to do so because it may erode their competitive position. The

problem is particularly true when managers are engaging in potentially controversial

activities, such as seasoned equity offerings, since outsiders such as security analysts are

apt to view the activity skeptically (Bowen et al., 2008; Henry & Koski, 2010).

The purpose of the current study is to investigate this very problem. Looking

specifically at SEO issuances, I identify three ways managers can disclose proprietary

information, and these three techniques vary in terms of the amount of proprietary

information disclosed. I suggest that providing justifications for the SEO reveals a great

deal of proprietary information, using information clarity helps outsiders process

information but may not always involve providing proprietary information, and casting a

positive organizational image often does not reveal any proprietary information. I then

look at the antecedents and consequences of providing information in each of these three

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ways. I suggest that competitive dynamics research helps to inform the antecedents, and

corporate governance research helps highlight the consequences of disclosing proprietary

information.

I hope to provide a number of contributions with this dissertation. First, I

introduce competitive dynamics as an antecedent of revealing proprietary information.

Specifically, I suggest that competitive intensity drives the type of proprietary

information managers disclose. I predict and find managers provide fewer justifications

and less information clarity when facing higher levels of competitive intensity. I also find

that managers cast a more positive organizational image when competitive intensity is

higher. Put differently, I suggest that managers are more concerned about releasing

proprietary information and doing so with information clarity when facing more intense

competition. At the same time, managers are more apt to speak positively about their

organizations when competition is more intense. I suggest this is because managers are

more concerned about the costs associated with revealing proprietary information when

competition is more intense.

Second, I introduce security analyst reactions to SEO issuances as an outcome

associated with revealing proprietary information. I predict that all three uses of

information influence security analysts, who have reasons to dislike SEO. I find that

security analysts tend to react less negatively to SEO issuances when managers provide

more justifications, and they react even less negatively when managers provide

justifications clearly. I also find that analysts react less negatively when managers cast a

positive organizational image. Interestingly, I find that analysts tend to react more

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negatively as managers provide information more clearly, which conflicts with my

hypothesis but may support the theory on obfuscation (e.g., Graffin et al., 2011).

Third, I introduce voluntary disclosure theory as a guiding framework underlying

when managers would choose to disclose proprietary information (Guidry & Patten,

2012; Lewis et al., 2013). At its core, voluntary disclosure theory is simple: Managers

will disclose inside information when the benefits outweigh the costs (Guidry & Patten,

2012; Lewis et al., 2013). To my knowledge, this is the first study that seeks to explicitly

lay out the costs and benefits of providing information, as well as what types of

information managers can reveal, all at the same time. When managers reveal

information and what types of information they reveal, however, represents an important

characteristic of a great number of theories within strategic management research (e.g.,

Connelly et al., 2011; Elsbach, 2014; Graffin et al., 2016; Zavyalova et al., 2012). Using

voluntary disclosure theory in this way can help scholars better understand information

disclosure. Further, voluntary disclosure theory itself has received scant attention in the

management literature. I expect this study will not only advance the constructs within the

theory but will help proliferate the theory itself.

Fourth, this study contributes to the corporate governance literature about market

reactions by examining how analysts respond to strategic announcements. I predict and

find that analysts may possess some skepticism about the purposes underlying an SEO

issuance and that managers can assuage this skepticism by providing justifications for the

SEO. Put differently, analysts often believe managers issue SEOs simply to capitalize on

overvaluation (Henry & Koski, 2010), even when managers may have value-creating

reasons that they can list as uses of the proceeds. I find that managers who provide

77

justifications are met with fewer analyst downgrades following the issuance and that this

is especially true when managers can provide justifications clearly. I also suggest that

analysts may hold some negative dispositions about SEOs simply because they are

controversial and not due to the merits of the SEO itself (Brown et al., 2015; De Bondt &

Thaler, 1990; Hong et al., 2000). I predict and find that managers can mitigate these

negative dispositions by casting a positive organizational image, which is consistent with

the voluminous literature on organizational perception management (e.g., Elsbach, 2014;

Elsbach & Sutton, 1992; Graffin et al., 2016; Zavyalova et al., 2012).

Research on the market for corporate control suggests that reactions from capital

market participants—namely analysts—to strategic announcements will shape the

choices managers make (Benner & Zenger, 2016; Finkelstein et al., 2009; Misangyi &

Acharya, 2014). This presents a problem for managers who are anticipating pursuing a

strategy they believe may efficacious but are faced with security analysts may who react

negatively to the announcement of the strategy (Litov et al., 2012). As Benner and

Zenger (2016) point out, managers may knowingly select less profitable strategies

because they think these are the strategies to which analysts will respond more favorably,

which is a problem corporate governance mechanisms tend to exacerbate. My hypotheses

and findings point to some ways managers can use their insider information to attenuate

this problem.

Fifth, this study contributes to the literature on proprietary costs, which is a term

scholars use to denote the downsides associated with revealing inside information. I offer

a theoretical rationale to help guide researchers‘ understanding of when the costs of

disclosing proprietary information are higher or lower. I introduce competitive dynamics

78

(specifically the construct of competitive intensity) to help better theorize about how

managers‘ perceptions of their competitive environment will shape their evaluations

when to reveal proprietary information. Competitive intensity provides a valuable

theoretical lens because it recognizes that managers‘ decisions are borne out of their

perceptions of the competitive environments they face; information disclosure is driven

by managers‘ perceptions about industry forces (Chen & Miller, 2015; Kilduff et al.,

2010). Although the proprietary cost literature is important because it examines what

influences the information managers provide to outsiders (Healy & Palepu, 2001;

Verrecchia, 1990b, 1990a), scholarship in the area suggests that there is currently very

little theoretical basis for conceptualizing and measuring proprietary costs (Ali et al.,

2014; Lang & Sul, 2014). Integrating the competitive dynamics literature helps resolve

this problem.

Finally, I contribute to the competitive dynamics literature by helping to further

conceptualize what competitive intensity entails. I connect competitive intensity to

information disclosure, which works to extend the theoretical conceptualization that

competitive intensity involves how managers perceive their environments instead of

competitive intensity being simply a characteristic of an environment. I find that

managers are less likely to reveal proprietary information when competitive intensity

increases. This is consistent with a recent line of research that suggests competitive

intensity is relational and idiosyncratic, meaning that it involves managers‘ perceptions

and their corresponding actions (e.g., Kilduff et al., 2015; Kilduff et al., 2010).

My conceptualization of competitive intensity as a managerial perception that

elicits action is also consistent with the broader competitive dynamics literature that is

79

focused on the strategic actions of a firm and its close set of rivals (Chen & Miller, 2012;

Yu & Cannella, 2007, 2013). However, the majority of research conceptualizes

competitive intensity as a static industry characteristic, such as concentration or density

(e.g., Ang, 2008; Barnett, 1997; Kotha & Nair, 1995; Li et al., 2008; Ramaswamy, 2001;

Su et al., 2015). I suspect this because when Barnett (1997) first theoretically

conceptualized competitive intensity, he suggested the construct is perhaps best

represented by the density or concentration of firms in a given market. My hope is that by

marrying competitive intensity to information disclosure, and conceptualizing them as

more action-orientated industry characteristics, scholarship will move in the direction of

seeing these constructs as more relational and idiosyncratic.

Limitations

Like all research, this study is not without its limitations. I measure competitive

intensity using competitive actions at the industry level, which can only merely represent

a proxy for managers‘ perceived competitive intensity. Some scholars have suggested

that competitive intensity is relational and idiosyncratic, meaning that it varies from

manager-to-manager in each firm (e.g., Chen & Miller, 2015; Kilduff et al., 2015; Kilduff

et al., 2010). My measure does not capture differences in managers between firms. In an

ideal setting, I may have accessed managers to either very closely study their information

disclosure or survey them about how they perceive their rivals and the costs of providing

information.

Another limitation of this study involves my assumptions about security analysts.

One may question whether or not analysts will appreciate having more information (i.e.,

justifications) as much as I suggest in this study. After all, would not analysts respond

80

negatively if competitive intensity is high and firms tip their hats to competitors by

disclosing information? Further, perhaps analysts‘ reactions depend on how the

information changes the competitive dynamics between the focal and rival firms. While

this is certainly possible, a good deal of the literature on security analysts (and the

perspective I employ in this study) contends that analysts are self-interested individuals

primarily concerned with their own job security and reputations (Brown et al., 2015,

2016; Ertimur et al., 2011). This research suggests that analysts are most interested in

remaining informed (Zhang, 2006a), being able to process strategies quickly (Litov et al.,

2012), and being able to provide information to their clients (Brown et al., 2015).

Accordingly, scholars have shown that managers can improve analyst reactions to

strategic actions simply by maintaining positive relationships with them (Westphal &

Clement, 2008; Westphal & Graebner, 2010), not to mention by providing analysts with

more information (Washburn & Bromiley, 2014; Whittington et al., 2016). Nevertheless,

I recognize that analysts interpreting competitive intensity and responding negatively to

information disclosure represents an assumption and limitation of this study.

How I measure security analysts‘ reactions is another limitation of this study. I

suggest that recommendation downgrades reflects analysts‘ distaste for an SEO issuance

and that fewer downgrades mean analysts perceived the SEO more favorably.

Admittedly, this variable is simply a proxy for analysts‘ preferences about how much

information they are provided. By observing fewer downgrades when managers provide

information, I assume that analysts preferred the information. A cleaner measure is to

survey analysts about their preferences and why they responded more or less positively in

one instance over another (e.g., Brown et al., 2015; Brown et al., 2016). This would help

81

me better approach the mechanisms connecting information disclosure to analyst

reactions, as currently there are any number of reasons why I may find a positive

relationship between providing more justifications and analyst reactions.

Studying only SEOs represents another limitation, and expanding the strategic

activities I examine may have helped better illuminate the mechanism underlying the

empirical relationships I found. As I discuss in the study, SEOs represent a relatively

unique paradigm as a controversial activity that requires information disclosure. By only

looking at SEOs, I may have missed some important information that security analysts

tend to consider when evaluating strategic activities (e.g., acquisitions, stock repurchases,

expanding, downsizing). Further, I used SEOs both as the event in which I am interested

and as the medium by which managers communicate information. I could have expanded

this to look at conference calls, press releases, media coverage, interviews, annual

reports, or any number of other information mediums. My reason for examining the SEO

prospectus is clear—it eliminates some of the problems associated with cheap talk (e.g.,

Almazan et al., 2008; Whittington et al., 2016). Regardless, expanding the events and

information mechanisms in my sample may strengthen or attenuate the relationships I

found. I suspect that limiting my sample to only SEO issuances helps reduce noise and

contamination empirically, but there is no way to definitively test that with my current

sample.

This study also carries an assumption that managers maintain some degree of

discretion over the information they disclose. I believe this is a reasonable assumption

given how the research on information disclosure describes managers as being able to

manipulate at least some of the information revealed in SEO prospectuses (Autore et al.,

82

2009; Walker & Yost, 2008). Still, other research has shown that managerial discretion

can vary drastically due to a variety situations, dimensions, and constraints (Crossland &

Hambrick, 2011; Daily & Schwenk, 1996; Hambrick & Quigley, 2013). I do not include

managerial discretion as a theoretical or empirical construct in this study, although it

could potentially inform how managers perceive the costs of disclosing information and

maybe even the benefits of doing so.

Finally, my conceptualization of the costs and benefits comprising voluntary

disclosure theory is not completely comprehensive. One can imagine how competitive

dynamics scholars may find benefits to disclosing inside information. For example,

perhaps firms are aware their competitors do not have sufficient resources to contend in a

market and may release their intentions in hopes of baiting their competitors to waste

resources (Chen et al., 2007). Similarly, one can envision circumstances when providing

information to outsiders does not elicit positive reactions. If the information provided

points to negative characteristics of the organization or relates to bad news, the capital

market will surely react poorly (Donelson et al., 2012; Skinner, 1994). The purpose of

this study was to paint with broad strokes to suggest these theories typically represent the

costs and benefits of providing information, not that they always do. \

Future Directions

The goals of this study are to examine the theoretical and empirical relationships I

discuss throughout this manuscript and to motivate future research. Accordingly, I

envisage a great number of future works related to the theories, data, and empirical

estimation in this study. I seek to resolve some of the limitations of this study in future

work, and I hope to expand the scope of my findings to new contexts and to solidify the

83

theoretical mechanisms I describe throughout this manuscript. In this section, I describe

several future studies I intend to build from this research.

The costs and benefits of perception management. I expect to build off the tenets

of voluntary disclosure theory to better examine when and why managers provide

information to outsiders. For instance, there is a broad literature on impression

management and how managers can provide information to outsiders, and thus improve

reactions to strategic announcements (e.g., Elsbach, 2003; Graffin et al., 2016; Graffin et

al., 2011; Washburn & Bromiley, 2014; Westphal et al., 2012). Research has been

noticeably quiet, however, about when one impression management tactic is more

effective than another. I suspect this is because scholars have not fully explored when

information is more or less costly to provide and when the benefits are greater or smaller.

Building on voluntary disclosure theory and the findings of this study, I can investigate

the circumstances and situations when managers are apt to pursue one tactic over another.

I can use the costs of providing proprietary information from competitive intensity and

the benefits of providing information to security analysts to determine the types of

activities that may benefit from more or less information provision.

Specifically, I can look at the competitive intensities managers face and the

potential benefits managers will receive for revealing information to outsiders, and I can

connect these to what kind of impression management technique they may choose to

employ. For example, perhaps managers facing less intense competition will provide

more descriptive information to outsiders about a potentially controversial activity (e.g.,

stealing thunder) than would managers facing more intense competition. Alternatively,

perhaps those managers in more intense competitive environments are likely to choose an

84

obfuscation technique that does not reveal proprietary information (e.g., strategic noise or

impression offsetting). I can test this by examining the range of impression management

techniques managers employ around a controversial event. An estimator such as a

multinomial probit would allow me to examine how competitive intensity drives the

likelihood of choosing one technique over another.

Upper echelons theory and perceptions of costs/benefits. I can build on the

research about managerial qualities, characteristics, and dispositions to better understand

how managers perceive the costs and benefits of disclosing information—namely the

work that uses upper echelons theory (Carpenter, Geletkanycz, & Sanders, 2004;

Hambrick & Mason, 1984). Indeed, a vast literature seeks to explain how managers‘

unique perspectives and situations inform how they interpret their environments and

develop corresponding strategies (e.g., Busenbark et al., 2016; Finkelstein et al., 2009;

Mannor et al., 2016). I expect to incorporate this research to better understand the

perceived costs and benefits that comprise voluntary disclosure theory.

For instance, I can examine how executive compensation influences managers‘

perceptions of the benefits associated with disclosing information. Following behavioral

agency theory, perhaps managers with in-the-money options are less concerned about

capital market reactions and will perceive fewer benefits to disclosing information than

managers with out-of-the-money options (Sanders & Carpenter, 2003; Wiseman &

Gomez-Mejia, 1998). Perhaps managers with in-the-money options will perceive more

costs associated with releasing information, too, since they are not as interested in taking

potential risks (Devers et al., 2007; Martin, Gomez-Mejia, & Wiseman, 2013). I also

expect to explore managers‘ personal characteristics, such as risk aversion. Maybe

85

managers who are more risk averse will perceive greater costs to disclosing proprietary

information than managers who are less risk averse, despite experiencing identical levels

of competitive intensity at an industry level (Christensen et al., 2014; Kahneman &

Tversky, 1979).

I can also examine managers‘ situational constraints, such as the structure of their

firms. Perhaps managers of diversified firms with several business units will perceive

different gains or losses from disclosing information about a business unit, especially

when units have different performance prospects or effects on firm performance (Arrfelt

et al., 2013; Arrfelt et al., 2015; Busenbark et al., forthcoming). Ultimately, there are

many theoretical lenses that inform how managers perceive their environments and make

strategic decisions, many of which I think can act as important moderators in better

investigating the costs and benefits associated with voluntary disclosure theory.

Competitive intensity and information disclosure. I intend to explore the link

between competitive intensity and proprietary information disclosure. As I mentioned

previously, introducing proprietary costs as a theoretical mechanism linking competitive

intensity to information disclosure represents a novel contribution of this study, but future

work can focus more specifically on that connection to clarify the relationship between

the two constructs. Particularly, I can focus directly on the theoretical dimensions

underlying competitive intensity and how these might relate to proprietary costs.

In the current study, I suggested several ways in which competitive intensity can

help theoretically inform managers‘ perceptions of the costs of disclosing information.

Competitive intensity can be idiosyncratic, it is often relational, it focuses on managers‘

perceptions, and it directly addresses competitive responses. Here, I focused primarily on

86

the competitive responses element of competitive intensity. In future work, I can more

directly investigate each manager‘s perceived competitive intensity and how it may

connect to how they estimate costs associated with information disclosure. I can do this

either by qualitatively observing managers, conducting surveys, executing a simulation or

lab experiment, or drafting a theoretical manuscript about these relationships. Put

differently, I can craft future studies to parse apart each of the theoretical elements

comprising competitive intensity to see how they drive information disclosure.

Performing experiments or simulations in a lab setting represents one intriguing

method I may use to better understand when managers think disclosing proprietary

information is more or less costly. I can image a simulation where participants are

provided valuable proprietary information that competitors can use to achieve a goal

before the focal participant. At the same time, I can stipulate rewards for providing that

information (such as increased reciprocal information from competitors or new abilities

to advance the participant toward achieving a goal). Doing so will demonstrate the

relative costs and benefits associated with disclosing information. I could manipulate the

number, competency, motivation, and stakes for and of competitors to see how that

informs participants‘ decisions to disclose information.

Differing stakeholder perceptions of proprietary information. I can expand the

potential benefits of information disclosure to contexts beyond security analysts. Indeed,

analysts represent only one of several key stakeholders about whom managers are likely

concerned (Agle, Mitchell, & Sonnenfeld, 1999; Hillman & Keim, 2001; Luoma &

Goodstein, 1999). While I explored the benefits associated with more favorable analyst

reactions, managers may be interested in responses from other stakeholders such as the

87

media (e.g., Bednar, 2012), other executives (e.g., McDonald & Westphal, 2011),

regulators (e.g., Beyer et al., 2010), communities (e.g., McDonnell & King, 2013),

investors (e.g., Graffin et al., 2016), or creditors (e.g., Klock, Mansi, & Maxwell, 2005).

It is quite likely that information disclosure will affect these other stakeholders in

different ways, such that some may respond more positively and others more negatively.

Put differently, the reactions of stakeholders to information disclosure may represent both

the benefits and costs associated with voluntary disclosure theory. In future studies, I can

examine how managers balance the potential tensions of different stakeholder reactions

so I can determine when the benefits of disclosing truly are greater.

New contexts beyond SEOs. I can also examine other strategic decisions beyond

SEOs. As I argue throughout this study, SEOs represent an interesting context because of

their controversial nature and because they are necessarily associated with some

information disclosure. Strategy scholars have identified several other important strategic

decisions that may not be as controversial or may not require as much information

disclosure; these may include acquisition announcements (e.g., Haleblian et al., 2009),

stock repurchases (e.g., Westphal & Zajac, 2001), corporate downsizing (e.g., Worrell,

Davidson, & Sharma, 1991), divestitures (e.g., Laamanen, Brauer, & Junna, 2014), or

strategic alliances (e.g., Hoetker & Mellewigt, 2009). I am particularly interested to see

how managers perceive the costs and benefits of information disclosure across a myriad

of these strategic decisions, especially when no information disclosure is required.

Conclusion

In this study, I suggested that agency theory and theories within competitive

dynamics provide potentially competing hypotheses about when and why managers

88

would disclose inside information about their firms. I highlighted how voluntary

disclosure theory may help to coalesce these two competing predictions. Using voluntary

disclosure theory, I posited that research in competitive dynamics helps to explain the

costs associated with providing information and agency theory highlights the benefits

associated with providing more information. I then identified three ways managers can

use information in SEO prospectuses. Justifications involve providing more information

to reduce asymmetry, information clarity involves how coherently information is

communicating, and casting a positive organizational image involves how positive

managers speak in the SEO prospectus. I hypothesized that competitive intensity

represents the costs associated with disclosing proprietary information and that outsiders

(e.g., analysts) may prefer managers to provide more, clearer, and positive information

about the SEO and their firms. I found support for many of my hypotheses.

89

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APPENDIX A

FIGURE AND TABLES FOR THIS STUDY

111

Figure 1 – Overview of the Model

112

Table 1—Descriptive Statistics and Correlations

113

Table 2—Testing the Antecedents of the Uses of Proceeds

114

Table 3—Testing the Consequences of the Uses of Proceeds

115

Table 4 — Industries Removed from This Sample

Industry Name

Agriculture and production crops, livestock, and services

Oil and gas extraction

Tobacco

Petroleum refining and related

Pharmaceutical

United States Postal Services

Air transportation

Utilities providers (e.g. gas, electric, water)

Depository and credit institutions

Security and commodities brokers

Insurance carriers and agents

Holding companies

Health services

Legal services

Education services

Social services

Government and regulatory agencies